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Analysis of the intrinsic profitability of segments A powerful methodology for strategic analysis September 2003 Example and approach 108 rue Damrémont.

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Presentation on theme: "Analysis of the intrinsic profitability of segments A powerful methodology for strategic analysis September 2003 Example and approach 108 rue Damrémont."— Presentation transcript:

1 Analysis of the intrinsic profitability of segments A powerful methodology for strategic analysis September 2003 Example and approach 108 rue Damrémont 75018 Paris arestan@arestan.com

2 © 2003 Arestan Consulting 2 Analysis of the intrinsic profitability (GB) Objectives of the module To understand the relative levels of profitability of segments in the business portfolio To identify the factors that drive the units current performance To grasp the evolution of the profitability of the segments in the next 2-3 years

3 © 2003 Arestan Consulting 3 Analysis of the intrinsic profitability (GB) 4 steps from analysis to comprehension and synthesis Design of the relevant economic model for success in the segment Target Market Share Target Marketing Mix: offer, price, presence, promotion Organization, headcount and costs for the value chain Profitability : EBITDA/Sales Design of the relevant economic model for success in the segment Target Market Share Target Marketing Mix: offer, price, presence, promotion Organization, headcount and costs for the value chain Profitability : EBITDA/Sales Quantification of the units performance in the segment Market Share, Turnover Cost structure Profitability : EBITDA/Sales Quantification of the units performance in the segment Market Share, Turnover Cost structure Profitability : EBITDA/Sales Evaluation of the gap between the current and the intrinsic performance Volume Effect Mix/price effect Productivity effect Non-quality effect ….. Evaluation of the gap between the current and the intrinsic performance Volume Effect Mix/price effect Productivity effect Non-quality effect ….. Identification Of key questions Identification Of key questions Methodological principles of the module (1/2)

4 © 2003 Arestan Consulting 4 Analysis of the intrinsic profitability (GB) Retained hypothesis Turnover and volume of an actor having a significant position in the segment Total costs of access to the market of an actor organized according to key success factors for the segment Direct Operating Margin (pre-tax) Sales = % The intrinsic profitability represents, in principle, the best possible performance, but under certain conditions, some actors could surpass this level due to their peculiar organization which are not reproducible by the majority of actors (see further in the case study Competitor 1 in Segment S1) Methodological principles of the module (2/2)

5 © 2003 Arestan Consulting 5 Analysis of the intrinsic profitability (GB) Module pre-requisites Segmentation Size Key Success Factors Key drivers of the segment Competition Segmentation Size Key Success Factors Key drivers of the segment Competition Clients active participation In the process Contribution to content Appropriation via exchanges Clients active participation In the process Contribution to content Appropriation via exchanges Intimate knowledge of The value chain Production Logistics Sales/marketing After sales service Infrastructure Intimate knowledge of The value chain Production Logistics Sales/marketing After sales service Infrastructure Analytical accounting ABC Analytical accounting ABC Volume, Market Share, Mix and price objectives Organizational structure Volume, Market Share, Mix and price objectives Organizational structure Evaluation of the cost structure of each link in The value chain Evaluation of the cost structure of each link in The value chain Quantification of the clients current position Evaluation of the gaps Quantification of the clients current position Evaluation of the gaps Discussions on the strategic level Remove the passion form the debate Discussions on the strategic level Remove the passion form the debate

6 © 2003 Arestan Consulting 6 Analysis of the intrinsic profitability (GB) Context in which the module can be applied Existing markets which are neither embryonic nor in total turbulence A sufficiently detailed segmentation to render a general analysis/study non conclusive or difficult to carry out Portfolio segments with distinctive strategic logics A concern, or even surprise, over the economic performance of the unit compared to its competitors in the segment

7 © 2003 Arestan Consulting 7 Analysis of the intrinsic profitability (GB) Example of an actual application Client (identified by TI) Producer of transformed industrial consumables integrated to a raw material producer Leader in the sector in Europe, without having any strong position on any of the segments Characteristics of the portfolio 5 identified major segments S1 : segment with strong links to the auto industry S2 and S3 : commodity segments S4 : non-differentiated segment, with specific service needs S5 : specialty segment

8 © 2003 Arestan Consulting 8 Analysis of the intrinsic profitability (GB) The utilized cost structure The model to calculate the intrinsic profitability of each of the 5 segments Turnover and volume of a significant actor in the segment Material costs Purchasing Production Shipping Sales/Marketing and customer service Research & Development Depreciation Direct Operating Margin (DOM) % DOM/Sales Intrinsic profitability of each segment (excluding general management and IS)

9 © 2003 Arestan Consulting 9 Analysis of the intrinsic profitability (GB) Illustrative example of the quantification (1/2) Market hypothesis (To evaluate the turnover and volume of a significant actor) S1S3S2S4S5 Identified segments Market size (Vol – Ktons) Market structure (% Direct) Market structure (% Distrib) Unit price Direct (Euros/t) Unit price Distrib (Euros/t) % Market share of the actor (The model actor and not the client) Sales volume of the actor (Kt) Turnover of the actor (MEuros) 90 100% 0% 1 647 NA 80 0% 100% NA 1 647 40 0% 100% NA 1 677 190 30% 70% 2 241 2 119 15 100% 0% 2 515 NA 25% 23 38 15% 12 20 15% 6 10 15% 29 63 40% 6 15

10 © 2003 Arestan Consulting 10 Analysis of the intrinsic profitability (GB) Illustrative example of the quantification (2/2) Evaluation of the cost of sales/marketing and customer service for the model actor S1S3S2S4S5 Identified segments Market manager ( Total costs= 230 KEu ) Technical assistance (tc= 150 KEu) Sales Administration ( tc= 75 KEu) Relationship management Turnover of the actor (MEuros) Cost of sales/marketing/service (KEu) (The model actor and not the client) 1 pers 2 pers 2,5% of TO (1) 1 pers 0 2 pers 1% of TO (1) 0,5 pers 0 1 pers 1% of TO (1) 2 pers 1 pers 3 pers 1,5% of TO (1) 1 pers 2% of TO (1) 38 1 630 20 580 10 290 15 755 63 1 780 (1) TO = Turnover

11 © 2003 Arestan Consulting 11 Analysis of the intrinsic profitability (GB) Intrinsic profitability of segments Level of profitability in % DOM/Sales S1S3S2S4S5

12 © 2003 Arestan Consulting 12 Analysis of the intrinsic profitability (GB) Some conclusions derived from the intrinsic profitability chart Even though the S1 segment is a technically oriented segment, its intrinsic profitability is very inferior to other segments. This could be explained by the fact that: The purchasing power of Auto equipment manufacturers pulls the prices down The race to reach the critical size among the competitor has accentuated the competition The sales and marketing efforts are not always remunerated because the equipment manufacturers can integrate ths activity at any time In this context, an actor in this segment is confronted with critical choices: Integration with a supplier of raw materials to take advantage of synergies (see Competitor 1 further) Achiving a significant market share (Competitors 1&2) A downstream move to take a bigger share of the alue chain without reaching the rank 1 equipment manufacturing stage The high intrinsic profitability of non-differentiated segments (S2, S3, S4), foretells an increased competition accompanied by price pressure, which actually reached 10-13% the following year In this context, survival in these segments dictates: An efficient organization of the entire value chain A significant market share to take advantage of the economies of scale and to increase the capacity to act as a leading market maker

13 © 2003 Arestan Consulting 13 Analysis of the intrinsic profitability (GB) Evaluation of TIs relative position with respect to the intrinsic profitability -10,0 -5,0 0,0 5,0 10,0 15,0 20,0 25,0 S1S3S2S4S5 Intrinsic profitability % DOM/Sales TI profitability % DOM/Sales Materials (incl. waste)Non qualityProductivity Volume Estimation of the contribution of each of the clients 4 issues to the gap with respect to the intrinsic profitability % Sales

14 © 2003 Arestan Consulting 14 Analysis of the intrinsic profitability (GB) Comments on TIs profitability gap The most significant gaps between TIs profitability and the intrinsic one in this segment emanate from the cost of non-quality and its sub-optimum size. Its advantage in materials (-3.7%) is offset by its above-average materials wastage. The gaps are mainly due to TIs insufficient size in this segment and the cost of materials (use of internal high quality, therefore expensive, materials, which are largely above the needs of the segment.) The gaps are mainly due to the cost of materials (see comments on S2), and the productivity linked to the use of xx technology instead of yy or zz. The gaps are mainly due to the cost of materials (see comments on S2), the productivity linked to the use of xx technology instead of yy or zz, and insufficient size. The gaps are mainly due to an above-average level of materials wastage S1 S2 S3 S4 S5

15 © 2003 Arestan Consulting 15 Analysis of the intrinsic profitability (GB) An example of a strategic deduction Estimation of profitability positions 3,2 pts = materials 1,8 pts = sourcing 1,0 pts = volume -0,4 pts = shipping 4,6 10,3 5,1 -5,2 -6,0 -4,0 -2,0 0,0 2,0 4,0 6,0 8,0 10,0 12,0 IntrinsicCompetitor 1 Competitor 2 TI % DOM (pre-tax) Sales Competitor 1 enjoys significant competitive advantages related to its total integration with the parent company (materials supplier), concentration on the segment, and a market domination Competitor 2 approaches the intrinsic profitability because its position resembles that used in the model. S1 % CA Segment S1

16 © 2003 Arestan Consulting 16 Analysis of the intrinsic profitability (GB) Arestan Consulting StrategyInnovationOrganizational Effectiveness Create the environment to get the most from new ideas and intuition Build balanced corporate structures and processes (rigor, flexibility, adaptability) to enhance a company s new ventures and intrapreneurship initiatives Develop Strategic Business Designs and Models for new ventures Develop Business Plans for new activities and innovative start-ups Design structures and organizations for effective corporate governance Build effective management processes (capital allocation, human resource management, budgeting, strategy and portfolio planning) Design efficient and decision enabling reporting tools and processes Improve the productivity and effectiveness of Sales, Marketing and Customer Service functions Develop and implement successful outsourcing strategies To obtain more further information on Arestan Consulting, you can contact us 108, rue Damrémont orTel : +33 (0) 6 11 48 20 56 75018 Paris - France email: arestan@arestan.com Create a dynamic business portfolio to deliver value through asset productivity Develop and implement strategies to deliver profitable growth through leveraging the company s core competencies and assets Transform the Business Planning exercise into a powerful business development and evaluation process Enhance profits through innovative customer- focused value creating strategies Develop innovative channel strategies Develop and implement customer driven key account management strategies Arestan Consulting works with executives and management teams on the development of their organizations future. Our collaborative approach is focused on the following expertise:


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