At the start of the pandemic, many companies made cuts to personnel costs to make up for declining revenues. Now, as the recovery begins, many midsize business leaders’ instinct is to rebuild their organizations as they were before. But this is counterproductive. Previously, midsize companies could succeed by selling to a broad market in a one-size-fits-all way. Today, leaders must understand their profit-based customer segments and organize to provide the right services to the right customers in the right way. Especially for midsize companies that have the agility to move fast and tie up the most lucrative customer segments, rightsizing is essential to lasting success.
As companies recover from their pandemic downsizing, they have a golden opportunity — and critical need — to reset their organizations to prosper in the era ahead.
When the pandemic caused the economy to crash, companies raced to stay solvent by reducing their costs to match their declining revenues. Most focused on slashing their personnel costs through downsizing or salary reductions, or both. For midsize companies without surplus resources or diversification, this was critical for survival. Time was of the essence, so most downsizing was largely implemented across the board.
In the post-pandemic period, many managers’ strong instinct is to rebuild their organizations as they were pre-pandemic. This is a big mistake — they’re facing a different business environment and set of customer needs. During the pandemic, giant digital competitors grew rapidly in response to changes in buyer behavior (e.g., B2C online ordering and direct shipment), which drove many smaller companies to the brink of bankruptcy.
The problem is that these changes aren’t going away. This means that companies, especially midsize firms, have to “skate to where the puck will be,” as hockey great Wayne Gretzky once observed. Simply rebuilding your previous organization, which seems like the obvious thing to do, is counterproductive. Your post-pandemic buildup, however, is an ideal time to make the fundamental organizational changes that the new era requires.
Fundamental Market Changes
As I’ve written about before, the phenomenal growth of giant digital competitors occurred along a relatively narrow strategic path: Arm’s-length services to small customers. These companies became experts in efficiently serving the needs of the “long tail” of small customers, which most businesses took for granted. This means that incumbent companies have a broad set of opportunities to build defensible, higher-service strategies. In the high-service segment of the market, however, customers have a diverse set of needs for largely integrated packages of products and related services.
For example, one of the first developments in what’s now called vendor-managed inventory was pioneered back in the early ‘90s by a midsize business, Travenol Laboratories, Inc., which was Baxter’s Canadian subsidiary in the hospital supply industry (this business was spun off and later acquired by Cardinal Health). The company was stuck in a price war for its commodity-like products, and there seemed to be no way out. Its managers tried to reduce their operating costs, but there were few opportunities to improve. It commissioned a small team to visit a few of their hospital customers to try to find a way out of its competitive jam.
The team was surprised to find that, after the supplies reached the hospital dock (where ownership passed), the internal hospital processes were very costly, primarily because they duplicated many of the company’s activities but without automation or scale. When they measured the actual internal hospital costs, they found that they were fighting over pennies in the price war, when there were dollars of addressable hospital efficiency gains that no one had seen.
In response, Travenol developed a new vendor-managed inventory service. The company placed warehouse supervisors that they called “materials management coordinators” in major hospital customers. They would count the products in every patient care area and clinic every day and send the information to the company’s distribution center, where it was packed into patient care area- and clinic-specific totes. The company delivered the totes to the hospital, and the materials management coordinator put the supplies away at night.
This system generated surprisingly large gains: Hospital costs dropped by double digits, company costs dropped as well (because they could optimize the number of orders), and amazingly, their sales to even highly penetrated hospitals increased by double digits. The latter stemmed from the close relationships formed between the company’s in-hospital materials management coordinators and the head nurses as they worked together to find ways to improve the system.
A complication arose. Many of the hospitals wanted different variations on the basic system. Some wanted deliveries only to certain clinics. Other hospitals only wanted the totes delivered to their receiving dock, while yet others wanted to do all the counting and putting away themselves.
The company’s managers were surprised at this proliferation of customer requirements. This was new to them because in the past, they had simply filled orders for their products and delivered them in bulk to the hospitals’ docks. Instead, they found that they needed to standardize the relationships they offered so they could produce a few variations of the new service at scale. (We call this a “relationship hierarchy.”)
They found that their functional, top-down organization was inappropriate for the new service because each hospital required a multicapability team composed of sales, product management, and supply chain management, and the teams had to be well coordinated and capable of forming tight relationships with their hospital counterparts. The company’s traditional command-and-control functional organization was actually preventing this from occurring because each team member reported to a different director with different goals and KPIs. For example, the supply chain managers were told to focus on cost reductions, not on providing new services (which were a great investment).
Instead, the company needed to decentralize planning and management into sets of multicapability teams, with specific teams specializing in each relationship. These teams required more and higher-skilled personnel than the functional organization did. They had to build personnel in order to rightsize these customer relationship teams, but this was a terrific investment.
When companies use new, granular, transaction-based metrics and analytics (creating an all-in P&L for every invoice line), they can quickly see that their customers (and products) fall into three broad profit segments: “Profit peaks,” their high-revenue, high-profit customers (typically about 20% of the customers that generate 150% of their profits); “profit drains,” their high-revenue, low-profit/loss customers (typically about 30% of the customers that erode about 50% of these profits); and “profit deserts,” their low-revenue, low-profit customers that produce minimal profit but consume about 50% of the company’s resources.
Profit segmentation provides the basis for resetting your company’s organization and rightsizing each component.
These customers are your prime profit generators. Your objective is to grow them by deepening your relationships. Intercompany integration processes like vendor-managed inventory build switching costs and strong revenue and profit increases through the tight relationships that form between your managers and their customer counterparts. As midsize companies increasingly move toward the higher-service segments of their markets, they need to adapt their organizations and build specialized capabilities to provide these advanced, semi-customized services.
This requires that companies decentralize their planning and management in this critical customer segment. Their goal is to create the multicapability teams that drive improvements in their premier customers’ businesses. This requires both close coordination among the company team members and excellence in working with their respective customer counterparts to manage change within the account’s organization.
The team has to have the savvy, experience, and capability to go far beyond the customer’s articulated needs. When a supplier meets customer requests, they’re a good vendor. But when a supplier finds and meets important needs that even the customer didn’t realize they had, they become a strategic partner.
For example, in the Travenol Canada case, hospitals were beginning to think about providing remote clinics for patient care, but they were concerned about their ability to service a network of remote locations. When Travenol offered its vendor-managed inventory service, backed by its enormous logistical capabilities, it reassured the hospitals that they could change their fundamental care delivery systems, which transformed the hospitals’ strategies and patient value footprint.
These teams require more and higher-skilled managers. In order to succeed in this critical customer segment, you need to increase your staff and upgrade their skills. This is an investment that pays rich dividends.
Profit drain customers present a different problem. They’re big, money-losing accounts. In our experience, most lose money because they have high costs to serve, not below-market prices. Some customers ask for a lot of unpaid extraneous services like custom labeling, while others order much too frequently.
Many of these problems are fixable, but they require a different set of multicapability teams. These teams have to be expert at changing the cost to serve by managing the relationship with these customers. Fortunately, in most cases, the customer receives a parallel reduction in its own cost. For example, if the customer is ordering too frequently (an important metric that very few companies monitor), it’s just as costly for them as it is for the supplier, so implementing the right order pattern is a win-win that often converts profit drain customers to profit peaks.
While the profit peak customer teams have to be expert at growing customer relationships, the profit drain customer teams need deep experience in changing the customers’ operations, similar to a bank problem loan workout group.
The answer, again, is to decentralize the organization, moving profit drain customer planning and management to a dedicated set of multicapability teams that parallel those dedicated to profit peak customers. Transaction-based profit metrics are critical because they can show a detailed P&L for each customer and compare the customer to the company’s own best practice (e.g., to a profit peak customer with similar characteristics). We call these potential improvements in a customer’s pricing or cost to serve “profit opportunities.”
In both segments, these teams require more managers than the previous functional organization needed, but this investment in rightsizing has a great payoff.
Profit desert customers are completely different. Most are simply small companies or larger companies with few high-volume needs for the company’s products (e.g., a major manufacturer buying a few ladders). The key objective in managing these customers is to lower your cost to serve. This is where downsizing through digital transformation (substituting automation for labor) makes sense. Managers can reduce costs by developing purchasing portals, automated distribution centers, and limited “menu” offerings.
While the profit peak and profit drain segments require more high-skilled personnel, the profit desert customer segment is where this kind of selective downsizing can free up resources to pay for the improvements in the other segments.
As companies emerge from the pandemic, they face a changed world. In the past, they could win by selling to a broad market in a one-size-fits-all way. Today, they have to understand their profit-based customer segments and organize to provide the right services to the right customers in the right way. This involves adapting your organization and management processes to the new mode of business. And, especially for midsize companies that have the agility to move fast and tie up the most lucrative customer segments, rightsizing is essential to lasting success.