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I believe that one of the more important analytical applications that a company can implement is profitability management. IBM Cognos offers Profitability Modeling and Optimization as part of its Cognos 10 offering that my colleague has assessed. As I’ve noted, most people in a corporation are focused on profitability, but not necessarily in a way that optimizes results across the organization in a day-to-day, consistent fashion. Those responsible for each component piece that contributes to profitability (such as departments, product lines or divisions) have objectives, but in pursuing these individual objectives they may make decisions that degrade the overall profitability of the corporation. Moreover, companies rarely seek to maximize short-term profits. They routinely make decisions that diminish their bottom line, such as promotional pricing, warranties or services included at no additional cost, with the aim of achieving strategic objectives. The question they must answer in making these decisions is whether these moves are justified. Similarly, they also must ask what they are including in their offer that they might be able to charge more for, such as shipping or warranties.

The IBM Profitability Modeling and Optimization analytical application gives companies the ability to accurately model the dimensions of profitability (by product, customer or channel, for example) in a consistent fashion. They can model the business to be able to reflect its true economic costs and see how changes in offer structure, pricing or cost components can affect profitability. The application’s in-memory processing gives users the ability to explore scenarios in an interactive fashion, encouraging more productive decision-making sessions. Executives and managers can brainstorm and then see the impact of various strategies. Properly constructed, the models will enable decision-makers to see all of the operational and financial consequences of a set of activities. They can easily integrate IBM’s SPSS analytics to do sophisticated historical analyses to determine if there are relevant patterns, correlations or market segmentation opportunities that they should consider.

The Profitability Modeling and Optimization application is aimed at a broad set of industries, but it has a solid base of customers in banking and financial services and includes specialized capabilities for these types of users. For example, the software can calculate retail and commercial bank customer profitability or branch performance. It can determine profitability by account and aggregate these across customer, household, branch, region and channel. It incorporates predictive analytics to segment customers with the objective of improving retention of valued customers and increasing customer satisfaction. And it can support pricing decisions for credit or noncredit products on a daily basis.

Of course, software is only one part of the effort required to manage profitability. The people dimension can be difficult to handle if the organization does not explicitly vest responsibility for managing enterprise profitability at a senior level. The company also must have people with the analytical capacity to create and maintain accurate models. Since business is not static, any profitability management process must be ongoing and performed in an interactive fashion – hence the need for an analytics tool that offers this capability and scales to a company’s requirements. And accurate and timely data must be readily available for analysis.

Profitability management with the objective of optimizing profitability is a discipline that few companies employ well. I think one reason has been the difficulty of executing the process in a way that conforms to how businesses operate. If the cycles of model, analyze and review take too long (which they are likely to if they’re not interactive), results can be difficult to justify. Today’s business environments are dynamic, so the value of decisions related to pricing, promotions and offers can severely diminish if it takes weeks or even days to explore scenarios, assess options and decide on a course of action. I assert that corporations should make profitability management a core competence and devote the resources necessary to master it. I recommend that companies looking for a tool to support a profitability management effort should consider IBM Cognos 10 for this as well as other performance management requirements.

Best regards,

Robert Kugel – SVP Research

Ventana Research recently completed groundbreaking benchmark research on how finance organizations use analytics these days. Of course, analytics have been a mainstay of finance organizations since people started using accounting ratios to assess the health and performance of a business. Yet perhaps because traditional analytics are so deeply entrenched, finance departments execute the basics well but don’t take the next step to fully utilize the power of information technology to use analytics more effectively. And they should: Our research finds that a majority of executives and managers outside the finance organization want the department to play a more strategic role in their company’s management.  

Finance tends to stick to the basics. The analytics research shows that when it comes to analytics, participants focus first on controlling operational expenses, managing budgets and keeping tabs on cash flow. In line with this focus, they identified operational expense (76%) and adherence to budget (65%) as the most important metrics they use, while ranking customer profitability (31%) among the least important. Yet focusing on the basics comes at the expense of using IT in innovative ways. For instance, the research finds that predictive analytics is a tool that just 13% of finance departments use but which can have a substantially positive impact on a company’s results, as I discussed in an earlier blog 

Moreover, I think finance departments can use analytics to take more of a leadership role in strategic management of corporate profitability. Some part of the organization needs to have ownership of strategic profitability management because otherwise it often falls between the cracks. A corporation usually has a strategy and almost always has profit objectives, but the two may not be well aligned. But there are challenges to doing this. One is that individual departments and business units focus on their own profit or cost objectives, but few companies have a process for systematically managing profitability across the business, which should include using a consistent analytical framework. So product organizations try to maximize product profitability, sales organizations may try to maximize revenue, and call centers may try to minimize costs. Individually, each of these moves may be rational, but collectively they can work at cross-purposes, and few companies focus on managing the sometimes conflicting objectives of individual parts of the business.  

I think Finance should take the lead in managing profitability more strategically for three main reasons. One is that the people in Finance are most likely to have the analytic and mathematic skills necessary for this role. The second is that it’s a natural extension of the department’s enterprise-wide responsibility for controlling spending. The third is that Finance will always be a neutral party when it comes to balancing the conflicting objectives of the various business units and departments that are individually trying to reach their own profit and cost objectives.  

I also believe that in a large scope finance departments need to redefine their role in the corporation to make it more strategic. Finance has spent the past two decades becoming more efficient by automating processes. It should now focus on becoming more effective, playing a more active and strategic role in the performance of the company’s operations, adding value by applying its analytic skills to the profitability of the business while spending less time on tactical “bean counting” functions. 

Analytics are the most important technology component that finance departments need in order to take a more active, strategic role in corporate management. It is also important to put the “A” back in FP&A to improve corporate activities. If you want the department to have more of an impact on the success of the business, information technology and finance analytics can be a foundation and catalyst for positive change. 

Regards,  

Robert Kugel – SVP Research

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