ACTIONABLE PROFITABILITY ANALYTICS

For Scott Wise (managing partner, Armada Consulting), the ability of FP&A to play a critical role
in decision making requires analysis and insights that enable a better understanding of what
drives profitability for an organization. In a presentation at the Live Future Ready Fall Learning
Lab in November 2019, Wise discussed actionable profitability analytics as an approach to
financial modeling and reporting that cuts straight to the core of what drives profitability for
organizations. In contrast to traditional accounting in the general ledger, which can be rigid and
two-dimensional, actionable profitability analytics allows an organization to track and model the
complexities of cost and profitability along a wide spectrum of dimensions, resulting in an
analysis that leaders can use for much more effective decision making.

WHAT IS ACTIONABLE PROFITABILITY ANALYTICS?

The power of actionable profitability analytics, Wise said, is its ability to “unravel the mystery of
which customers, products, geographies, markets, or lines of business make the most impact on
profitability.” Each customer, product, service, or market can potentially impact profitability in a
different way. One customer, for example, could require a vendor to set up an intricate in-store
display for a beverage while paying the same price for the product as other customers who
require no display. “There are all sorts of differentiations,” Wise explained. “Our job as FP&A is
to identify what they are, model them in a way that allows us to predict how they will impact
different drivers of the organization, and deploy the models to users who can use them to make
more profitable decisions on a regular basis. That’s actionable profitability analytics.”

Organizations that can successfully leverage profitability analytics can move beyond descriptive
and predictive analytics to prescriptive analytics in ways that help drive the business forward.
“Prescriptive analytics is about taking the next step and asking: What can I put into the user
community that can help them make decisions on a daily basis? How do I reduce the uncertainty
of the decisions that they have to make? The value of actionable analytics is that I can start
putting permissive or preventative decisioning in play with analytics. That’s what I mean by
actionable,” Wise explained.

STRATEGIC COST MODELING

Strategic cost modeling plays a key role in actionable profitability analytics by connecting cost to
profitability. The goal of strategic cost modeling is to identify a traceable causal relationship
between customer choices and their impact on expenses. “The primary function of a
profitability system is the alignment of costs to revenue sources in order to drive improvement

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 decisions,” Wise explained. Costs are the most controllable part of the profit equation—Once
FP&A teams understand how costs operate in an organization’s business model and can connect
different kinds of cost to their impact on profitability, FP&A can design more effective models
for decision-makers.

Actionable profitability analytics require multidimensional cost modeling because cost is a wide
umbrella that encompasses everything from the cost of capital to the cost of products, funds,
services, and more. One of the biggest challenges with traditional accounting is that the general
ledger (GL) in which transactions are recorded is two-dimensional, rigid, and ultimately unable
to account for these complexities.

There are other challenges beyond the GL that make cost accounting and modeling difficult. For
example, Wise said, governance over profitability data and reporting is important because “a big
part of our job is to set those guiding principles that everybody is going to adhere to, preferably
before anybody sees results and starts jockeying for position. But this robust sense of
governance for profitability is often missing in organizations: “While we have very well-
established regulatory and GAAP rules around accounting, we don’t with profitability—it’s really
more of an art.” This situation is made even more complicated by the wide variety in systems of
record, Wise said. Some solutions are built to be incredibly flexible and customizable but are
ultimately too complex and confusing to use for modeling, while others are far too rigid to
model the complexities of cost and profitability in an actionable way.

The key question for modeling cost-effectively, Wise said, is: “How do we transition those things
that we are measuring from a P&L perspective to go outside the construct of the two-
dimensional GL and really have a set of measures that provide actionable information about
those costs?” Wise used banking as an example to describe a model for strategic cost
accounting that accounts for the complexities of cost to build clear, causal relationships
between an organization’s products and services and its customers. The model in Figure 1
depicts the relationship between a banking customer, one of the bank’s products (a loan), and
the processes and resources used to deliver the product.

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 Strategic Cost Model

Figure 1

The benefit of a model like the one in Figure 1, Wise said, is that it highlights three different
areas in which an organization can act or make decisions.

1. The right side of the model includes costs in the form of business unit expenses like
outsourcing contracts or shared services demand. Organizations should look at this end of
the model to think about how to remove things like unnecessary discretionary spending to
deliver their products in a more cost-effective way to drive profitability.
2. The middle part of the model, meanwhile, is focused on the costs of processes. Reducing
non-value-added work through approaches like Lean can make processes more efficient and
ultimately more cost-effective.
3. The left side of the model “really starts answering the questions about the markets where
the bank can be most effective. If we understand how customers are consuming our services
and products, we can really start to dissect customer profitability across a number of
different segmentations.” Understanding how customers drive cost and profitability also
helps an organization to think more carefully about delivery channel rationalization, how to
improve pricing decisions, and how to design and enhance the organization’s products.

Dimensional Tree Models

Dimensional tree models like the one in Figure 2 zoom in even more closely to look at the costs
associated with a particular customer account using revenue data, balance data, and the cost of
products. Wise said that dimensional structures will look different from one industry to the next.
For example, in the medical industry, the base of the tree would be a procedure, while in the
food and beverage industry it might be an order invoice. The key question for the dimensional
model is “What is that cornerstone receiving dimension that will give you access to all of those
other dimensions that you want to use to measure profitability?”

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 Dimensional Tree Model for Banking Customer

Figure 2

Identifying the dimensional structures of cost and profitability is only half the battle—the other
half is connecting the model to an audience of decision-makers in the right way. “That’s the part
of storytelling that we don’t do very well in FP&A,” Wise said. “We put the pretty dashboard up
and think that if we build it, someone will figure out what to do with it. We need to be much
more proactive in connecting with our audience.” It is equally important for FP&A to “set the
rules of engagement, centralize all profitability analytics, and deploy that to the users,” by
ensuring that all data is coming from the same source. FP&A should play a leading role both in
the interpretation of financial data for different audiences and in setting the boundaries of what
it means to report and discuss financial data, which helps ensure that models are accessible and
comprehensible to decision-makers.

COMPONENTS OF AN EFFECTIVE AND SUSTAINABLE

FRAMEWORK
A sustainable framework for actionable profitability analytics requires a careful balance of
methodology, technology, and data. With every modeling decision, the organization must
consider its capabilities to sustain a repeatable solution based on factors like production
frequency, resource constraints, and process efficiency. Using actionable profitability analytics
to drive profitable business behaviors requires three key components, Wise said:

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 1. Transparency—to measure what is manageable and meaningful to the business and
provide actionable information to key decision-makers.
2. Transformation—to establish governance and ground rules for dialog around analytics and
create accountability.
3. Tenacity—in order to ask the tough questions, act decisively and stick to the plan.

Engaging the business on profitability analytics also requires a coordinated effort on the part of
the back office, front office, and finance to create a shared agenda for driving profitability. The
back office should work to control costs without limiting growth by providing transparency into
the cost of services provided; managing capacity and utilization levels; monitoring efficiency and
performance measures, and collaborating with the business to remove unnecessary costs. The
front office, meanwhile, plays an equally important role by working to maximize profitability and
achieve sustainable growth by providing credible analytics on profitability and performance;
cost data that hold service providers accountable; transparency into the drivers of unit costs;
and improved pricing and capacity utilization. Finance mediates between these two entities by
educating and engaging the right stakeholders with actionable analytics that drive profitable
behaviors.

CASE STUDY
The fundamentals of using actionable profitability analytics effectively can be summed up
concisely in three Cs, Wise said:

1. Connecting profitability analytics to a meaningful business problem and to decision-

makers.
2. Credibility that comes from applying data, methodology, and technology consistently to
drive more profitable behaviors.
3. Clarity in communicating a clear and concise call to action for decision-makers.

As an example of the three Cs in action, Wise described a case study of an organization that was
interested in leveraging actionable profitability analytics across the enterprise and wanted Wise
to create a proof of value. Growth in the organization had stalled over the last several quarters,
and the sales team claimed that they could not price competitively due to a high cost per unit
from operations. The organization was considering outsourcing its production (which would
reduce operational costs by over 20 percent) and wanted Wise to focus his efforts on this
decision. Was it the right move to make?

“We went in, did cost studies, and if you looked costs across various different sites it would
probably still make sense to make the decision to outsource. But when we looked at the
organization’s processes, we saw a very different story. All of the additional costs that the
organization was seeing were related to exception processes that had been growing over the
last 2 to 3 years.” Wise found that process improvements would reduce costs much more
effectively than outsourcing. Once he presented the data in a clear and effective model to the

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 organization’s COO, “It was like she put 3D glasses on and could see the picture in a very
different way. With that one slide, not only did we win the project and implement it across the
enterprise, but the organization saw five million dollars in savings by the end of the year.”

KEY TAKEAWAYS
To craft the most effective financial performance framework possible, organizations should
make the journey to implement actionable profitability analytics. “The view is worth the climb,”
Wise said, because it allows an organization to move from two-dimensional cost allocations in
the GL to “more consumption-based, multidimensional profitability analytics that allow us to
have the customer lifetime value discussion from a predictive perspective.” Wise said
organizations should ask three questions as they consider whether actionable profitability
analytics is right for the business:

1. Does profit inequality exist within your business? If so, identifying differentiation by
customer, product, region, and other factors will yield insights that can transform the
business and build a competitive advantage.
2. Is the accounting of the business hiding actionable information? Two-dimensional
accounting across organizational units can limit performance accountability, obstruct
collaboration, and cause complexities that keep finance from value-added analytics.
3. If given the right information, will users do the right thing? Information is only as
valuable as the action it initiates. Credible profitability analytics deployed to the right users
will drive more profitable behaviors and increase corporate financial performance.

ABOUT APQC
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ABOUT LIVE FUTURE READY

Live Future Ready™ is a shared-learning member network focused on implementing advanced
planning processes, improving management models to become more adaptable, and
empowering their organizations to enable sustained superior performance. Live Future Ready™
members are also members of the Beyond Budgeting Round Table North America (BBRTNA).

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