PROFIT FROM ROOT CAUSE DRILL DOWNS
24.07.2019
I’ve written a lot about why it’s important to understand financial statements. And even discussed the importance of key performance indicators (KPIs). But there’s another step beyond this understanding. What is it?
It’s establishing the best way to continue, or enhance, the good trends we see in these results, while at the same time detecting and removing those things that are causing a less-than-good trend in the results. And how do we do this?
By drilling down to the base-level data.
This means, of course, that we need to not only understand the financial statements and KPIs, but also the data from which they are derived. And not just a little high-level data. No, what’s needed is a fair quantity of baseline data.
Douglas Merrill put it this way:
Taking it further W. Edwards Deming said:
Dan Zarella applied this to business when he stated:
Yet, it’s more than just marketing. Every part of the business needs, and must be driven by data. It is data that must be used for decision-making every step of the way. Now it’s not always easy — and it’s up to the business to ensure systems are in place to capture the necessary data — but it’s worth it.
Steve Jobs recognized this in saying:
Now he was, no doubt, talking about getting product development right. But this principle applies equally to finding the root causes of results we’re seeing — so we can do what’s needed to:
- Replicate (or even improve) the good results, and
- Eliminate the causes of bad results.
So we must drill down — even though that takes some time — to find out the root cause of the results we are getting.
Let’s discuss some scenarios along the lines of ones I’ve observed, but which could easily be happening in a business near you — or even your business — every day.
Scenario 1
Overall Scenario — The profits in a multi-branch retail chain were declining.
Drill down level 1 — Store-by-store results show profit decreases in a particular store contributed to this.
Drill down level 2 — Product category sales data show margin decreases on some high-ticket product lines.
Drill down level 3 — Inspection of item sales data shows that team members have been offering significant discounts (unasked!) as part of the sales process. (This, obviously, also involved discussion with the team.)
Discovery 1 — The system allowed any team member to enter this discount. I.e. there was no discount authorization process built into the system.
Discovery 2 — Team members did not realize that:
- They should not have been doing this, or that
- There was a better way.
Change 1 — The system authorization process was implemented.
Change 2 — Training was given, so team members began offering a couple of small accessory products — when necessary (only) — which may have had the same retail value as the discounts being offered, but cost the business considerably less.
Effect 1 — The offering of large discounts ceased — so sales and margins went up.
Effect 2 — Customers actually started purchasing extras of the accessories — because they wanted more than the quantity given as part of the main sale — so sales and margins went up.
Effect 3 — Team members so took on board the training that the level of cross-selling went up considerably.
Consequence — The problem identified was not only rectified but reversed.
I think you can see that the process was well worth following. Also, it’s plain that good systems — ones that capture the base data in an accessible way — are essential.
Scenario 2
Overall Scenario — the Inventory figure on a manufacturer’s books was increasing and cash declining.
Drill Down 1 — Cash was discovered to be down chiefly because of paying for the extra inventory.
Drill Down 2 — A review of the inventory holding showed that there was a continued, unexplained, growth in the holding of a particular part.
Drill Down 3 — Analysis of transactions showed minimal usage of the part.
Discovery 1 — The usage recorded against the part showed it was used in a particular type of product.
Discovery 2 — Analysis of purchasing showed the part was included in the parts listings for other products, for which it was not needed.
Change 1 — The parts listings were amended to remove the part in question.
Change 2 — All parts listings were reviewed, and other errors were corrected.
Effect 1 — Parts ordering was now correct. Over time inventory went down and cash went up.
Effect 2 — More care was taken in creating new products on the system, to ensure parts list accuracy, leading to greater purchasing accuracy.
Consequence — Once again, the problem identified was not only rectified but reversed.
Once again the process was worth following. And, again, good data capture was essential to enable the drill down required.
Scenario 3
Overall scenario — sales and margins in an engineering firm were down, yet sales commissions were not.
Drill Down 1 — Two of the business units within the firm were the contributors to this, with one (we’ll call it Unit A) reflecting lower sales, but similar margins to usual — in spite of increased sales commissions. The other (Unit B, say) had lower margins as well.
Drill Down 2 — Analysis of sales data showed sales in Unit A were actually down in quantity, as well as value. However, Unit B’s sales quantity was fairly stable.
Drill Down 3 — Examination of sales commissions showed that — in both units — sales commissions were paid based on orders taken, not sales made (and paid for).
Discovery 1 — The salesperson in Unit A would do anything to get an order (and therefore commission), regardless of whether the products could actually be provided by the time the customer wanted them, or even whether the customer was likely to pay.
Discovery 2 — The salesperson in Unit B, meanwhile, wanted the orders (=commissions) badly enough to offer prices that were guaranteed to get the order, regardless of the profit consequences to the firm.
Change 1 — The commission policy was changed to make commission payable only on sales made and paid for.
Change 2 — Both a pricing structure and an approval procedure was put in place in regard to the pricing of sales offers.
Effect 1 — Sales in both units went up, as did margins.
Effect 2 — Cash also went up — in line with greater sales and the incentive to ensure they were paid for.
Consequence — In this scenario also, the problem identified was not only rectified but reversed.
The drill down process again proved its worth. This scenario also relied on good data capture.
Don’t forget that the pursuit of the base level data is a pursuit of the truth — the thing that is truly causing the effect you observed in the beginning. After all, as Arthur Conan Doyle said:
I think you can now see that there is a sequence here:
- Understand financial statements;
- Know your KPIs — what they mean, what drives them;
- Identify potential issues and opportunities;
- Drill down to the next level;
- Drill down again (as many times as required);
- Fix the problem or replicate the success;
- Profit from the process.
So, remember the process — and how valuable it is — then you too can profit from root cause drill downs.
This blog was first published at www.beanstalkknowhow.com on 24 July 2019.
