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Extending Your Business Performance Management Initiative with Profitability Analytics, Part 1

Originally published August 11, 2009

In February, 2009, I wrote an article for the BeyeNETWORK entitled “Measure Twice, Cut Once: A Case for More Effective Profit Optimization.” Since that article, profitability optimization and the supporting profitability analytics technology capabilities have continued to evolve and have greater visibility in advanced performance management deployments. In particular, many companies that are engaging in these types of analyses are focused on maximizing profit through both creating operational efficiencies and carefully reducing costs. The good news is that with this increased focus, the vendor community has converted technology that was once only available for very large, very expensive custom initiatives and made it more available for mid-sized to large companies with more modest budgets.

As mentioned in the earlier article, the 2009 BPM Pulse Survey results clearly demonstrated the importance of profitability in today’s economy. Nearly 50% of the survey respondents commented that profitability optimization is more important in today’s more challenging economy (survey conducted October 2008 through February 2009).

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To create additional clarity around this growing area, it is helpful to first establish some clear definitions. Borrowing from the BPM Standards Group, the following is a definition that was developed in 2005 by a combination of leading vendors, analysts, service providers and end users:

Business Performance Management (BPM)
  • A set of integrated, closed-loop management and analytic processes, supported by technology, that address financial as well as operational activities. BPM enables a business to define strategic goals, and then measure and manage performance against those goals.

  • The core BPM processes include financial and operational planning, consolidation and reporting, modeling, analysis, and monitoring of key performance indicators (KPIs) linked to organizational strategy.
Building on this definition, BPM Partners, working with several members of the vendor community and leveraging experience from end-user engagements, proposes the following definitions for profitability analytics and differentiation from its supporting technology kin, activity-based costing:

Profitability Analytics
  • Enhances detailed data from operational systems, such as enterprise resource planning (ERP), general ledgers (G/L), customer relationship management (CRM) and supply chain management (SCM), involving functional areas like procurement, finance and sales. By focusing on three core business drivers (customers, products and processes), enterprises can target initiatives that directly affect profitability.

  • Users can analyze and make profitable adjustments across any dimension of their business – customer, product, vendor, channel, supply chain, pricing – leveraging transaction data and applying profit analytics.
Activity-Based Costing
  • Activity-based costing (ABC) is a costing model that identifies activities in an organization and assigns resource costs based on actual consumption; it assigns indirect costs more appropriately than traditional cost accounting systems.

  • The ABC methodology assigns an organization’s resource costs through to activities (work performed) and then to the products, services and customers for whom the work is performed. It is generally used as a tool for understanding product and customer cost and profitability.
With these definitions in place, one additional area of clarification can be established on differences between BPM and profitability analytics.

Business Performance Management
  • Provides a centralized repository for summary level information.

  • Extracts from numerous source systems.

  • Is optimized for summarized budgeting, planning, forecasting, financial consolidations and reporting.
Profitability Analytics
  • Provides ability to analyze by product, client or channel down to transactional level detail.

  • Supports operational decision making by business unit, region or product line management.

  • Requires sophisticated allocations/assignment engine based upon operational (revenue and cost) drivers.

  • Digs beneath straight gross margin analysis to net/economic margin.
The key to note in these differences is that business performance management typically leverages a combination of multidimensional and relational database technology to help summarize enterprise-wide information in an easy-to-access manner. Profitability analytics requires more detailed data, complex rules and allocations engines, and often real-time links to transactional data.

From a technology architecture perspective, the first of the following images shows a traditional performance management structure building upon BPM Standards Group research, while the second illustrates how a drill down into the “monitor and analyze” area shows enhancements necessary for a parallel approach for BPM and profitability analytics deployments.

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In the profitability analytics framework, you will note the specific focus for process modeling, capacity utilization and root-cause reporting, while also noting the need for a strong business rules engine to help with the analysis.

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These important foundation definitions and illustrations will be helpful for organizations in early stage consideration for enhancing their performance management initiative into a broader series of profit optimization initiatives. Part 2 of this article will focus on specific examples of types of profitability analytics and best practices for successful deployments.

For more information about vendors that provide these types of analytics, see the following links:



  • John ColbertJohn Colbert
    John, Vice President of Research and Analysis at BPM Partners, is responsible for market trend analysis, services development and technology vendor relationships at BPM Partners, the leading independent authority on business performance management (BPM) solutions. Prior to BPM Partners, John was Senior Director, Product Marketing at Hyperion Software, responsible for directing Hyperion's OLAP Business Analysis financial software products. Earlier in his career, John was an end user of performance management solutions while a product manager at Raychem Corporation, a Fortune 500 company that has since been acquired by Tyco. John has contributed to many publications including the New York Times, BPM Magazine, Information Week, Business Finance and eWeek, and he is a regular presenter at performance management related conferences and web seminars.

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Comments

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Posted August 12, 2009 by Gary Cokins gary.cokins@sas.com

John does a nice job framing profitability analytics. Emphasis should be noted that CFOs should not stop at just product and standard service-line profit margin calculations, but go further below the gross profit margin line and also trace and assign the cost-to-serve expenses of distribution, selling, marketing, invoicing, customer service, etc. expenses. Arguably products and service-lines have become commodities in most industries and a competitive edge from them is therefore neutralized. Sales and marketing need to consider differentiated services to different customer micro-segements to optimize the payback on their deals, offers, discounts, cross-sell, upsell, etc. --- viewing customers as an investment portfolio to optimize shareholder wealth creation. It is no longer about growing sales, but growing sales profitably.

My minor debate with John is positioning profitability analytics as "different" from business performance management. My belief is performance management is an umbrella and many methodologies in addition to profitability analytics (including strategy maps, scorecards, dashboards, dynamic price optimization, etc) are all integrated under BPM ideally with each methodology imbedded with business analytics.

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