Beyond the numbers
The way the organization competes in the market will affect the staffing plan, the level & speed of development, routes-to-market, supply chain and leadership decisions. This, in turn, affects the structure of the P&L and the balance sheet. It is only through this clear definition that a financial plan can be formulated and ensure that the answer yields adequate profit.
A basic foundation of strategy is to understand if the business will compete by having lower pricing or if the business will provide differentiation to competitors. The answer is rarely straightforward and usually judgment is involved of where in the spectrum it falls. The answer also usually follows competencies where it aligns to skills, background and processes best suited for the strategy.
Examples of traits for each competency are:
Low-Cost Provider Competency
- Ability to secure lower procurement costs.
- Global resourcing of labor or products.
- Standard product or service offerings.
- Integrated Supply Chain.
- Preferential vendor agreements.
- Operational efficiently.
- Ability to engineer products or processes ahead of market.
- Speed of development.
- Product quality.
- Delivery excellence.
- Frequency & availability of services.
This may appear to be an obvious first step, but it rarely gets meaningful consideration. Often businesses meet transformational events with an execution plan that does not take into account competencies. It is an easy item to overlook as teams focus on the event but fail to understand how it fits into the organization’s abilities. If there are incompatibilities between the execution plan and competencies, they must be addressed upfront or the event needs to be reconsidered.
It is also important to consider that modifying organizational competencies is a challenging endeavor all by itself. One should take caution when assuming that a competency can be built in parallel to handling a transformative event. For example, a company that excels at driving cutting-edge technology may not easily adapt to entering a market that is commoditized without having to modify skills, staffing and vendor contracts through the organization. It is therefore advantageous to align the operating direction of the event to existing organizational competencies, versus changing competencies.
The underpinnings of the direction will drive the P&L. Businesses that have identity conflicts or confusion in the strategy can be spotted in the structure of their P&L, where there is a disconnect between the amount of infrastructure and the level of sales or gross margin. In other words, they lose money because SG&A/R&D levels are higher than the revenue and gross margin line allows them to be. They are misaligned to competencies.
The selected strategy will influence price points, procurement/delivery, route-to-market and channel margin. Once the strategy is established, the financial framework can follow. A business that seeks to compete on cost will usually have lower gross margins. It can also have lower net margins but maintain profitability through higher asset turnover – that is if it can yield higher revenue relative to the assets in the balance sheet. This is usually accompanied by higher market share. Conversely, a business that aims to have a differentiated product will usually have higher gross margins since it commands a price premium, but development and SG&A are often higher relative to that of a low-cost provider.
Another important dimension in defining strategic direction is establishing, or clearly defining, the sales route-to-market (RTM.) How the organization distributes its product will affect gross margins and will require sales resource alignment. Simplistically, a route that heavily relies on distributors (or other forms of third party resellers) will drive lower top line revenue, lower gross margin, with an offset in lower sales expense. Conversely, a route that depends on direct in-house sellers will result in higher revenue and higher expense.
This analysis assumes that profitability is neutral as market price points are equal in both scenarios. However, in many cases the RTM can influence price points particularly if there are differences in skills, or enablement, between one and the other.
Once competencies and routes-to-market are defined, they can serve as indicators of how the organization should be aligned. One main dimension in organizational structure is personnel. Most of the infrastructure in organizations is made up of headcount expense. Therefore alignment of personnel, both in terms of quantity and position, is essential to establishing a successful financial structure.
An asset-organization with a differentiation strategy will place greater emphasis on product development either by hiring more developers or by hiring more skilled developers. Conversely, an asset-organization with a low-cost strategy will elect to maximize efficiencies.
Resource alignment is also essential with regards to route-to-markets. An organization that relies on sales via distributors would likely have fewer direct sellers. Often both routes are considered important to the sales function but stacking them creates an expensive SG&A E/R. In cases with multiple RTM’s, organizations should take note of sales productivity for its direct sales team. Sales dollars per headcount is a revealing metric when trying to determine if the organization is staffed for efficiency.
Resource alignment plays a pivotal role in top line and bottom line growth. An analysis of the organization should be benchmarked to a desired structure, following one of the templates above. Often, that comparison will highlight areas that need reductions, increases, or if optimally staffed, re-skilled.