Chapter 1
Background
Indalex Aluminum1 was the largest producer of soft alloy extrusions in North America and second only to Alcoa in total aluminum extrusion production. A series of large acquisitions from mid-1999 to early 2000 propelled them from a seven-plant business, principally in Canada, to a 19-plant network (on paper) spanning North America.To understand the work at Indalex Aluminum you have to go back to an article written by Larry Selden and Geoffrey Colvin from Fortune2.
In interviews with senior managers they asked...
Who are your unprofitable customers? The truth was that some of their customers were deeply unprofitable. Simply doing business with certain customers was reducing profits and shareholder value. Other customers were fabulously profitable--but the effect of the bad-news buyers was over-whelming them. The managers didn't understand any of this. They didn't understand that their customer strategy--their whole plan for acquiring, maintaining, and developing customers was determining their customer profitability, and crucially, that their customer profitability was in turn determining their share price.
Get ready for a big idea that's about to sweep through most companies: managing the enterprise not as a collection of products and services, not as a group of territories, but as a portfolio of customers. Most managers don't understand how their customer portfolio determines their ultimate bottom line: the value of the company. Believe it or not, it's entirely typical to find that just the best 20% of a company's customers generate a huge portion of its share price--in some cases, all of it. The trouble is, the worst 20% may destroy a ton of value, with the middle 60% making up the difference. Until a company starts managing its highly diverse customer portfolio, it can't hope to maximize shareholder value.
Many companies have spent millions on the needed software--including ERP (enterprise resource planning), CRM (customer relationship management), and many other applications--with little or nothing to show. That's because cashing in on customer profitability requires a deep change in corporate mindset, something no vendor can sell you. The customer portfolio needs to become the basis of how companies get organized, measured, and managed. Making this switch is tough.”
This Indalex case study is not about the software. It is about a vision to create a dramatically different organization. This case is about organizational transformation. From a hodge podge of subgroups that were mildly profitable to a dynamic, integrated and focused organization.
I met Mike Alger3 at Indalex aluminum in 2002. Mike was the Executive Vice President and CFO.
Alger had read Selden and Colvin’s article in Fortune and in an article in Strategic Finance4 he later wrote about his vision...
We had chosen a clear direction. We intended to maximize shareholder value by truly managing our highly diverse customer portfolio.We had chosen to operate our business not as a collection of products, services, and assets, not as a group of territories, but as a portfolio of customers that can be managed in the best interests of our company and our customers alike.My work with Indalex was to be ground breaking. They were able to segregate portfolios of customers, develop value strategies that transformed several unprofitable portfolio’s and most importantly to paraphrase Selden and Colvin... The customer portfolio became the basis of how company was organized, measured, and managed.
When I met the team made up of Mike Alger, Executive Vice President and CFO; Tim Stubbs5, Vice President Marketing; and Mark Doig6, Controller at the Mississauga plant, which was the largest plant in the group, they had already come to terms with the fact that their cost system was inaccurate and would be a huge hinderance to meeting their new strategy.
They were planning to grow rapidly and build a dominant position within a consolidating industry. To do this they had to transform a mature, successful company into a growth-oriented, customer-focused leader.
The team had read Selden and Colvin’s article in Fortune and this made perfect sense to them. Alger was initially, the point man on the project. He fundamentally believed that Indalex could fit into Colvin’s model, the best 20% of their company’s customers were generating a huge portion of profitability and the worst 20% was destroying what seemed to be an equivalent amount of value. The problem was he was not able to properly measure those customers.
The change process began before I was involved in the project. This team had a vision.
To quote Alger...
(To meet our growth target)...We had chosen to operate the business not as a collection of products, services, and assets, not as a group of territories, but as a portfolio of customers that can be managed in the best interests of our company and our customers alike.
As luck would have it, my work linked into their thinking and we set off to establish a new paradigm for managing a huge multi-national, multi-plant organization.
The senior management strategy was to rapidly build a dominant position in a consolidating industry and transform a mature, successful company into a growth-oriented, customer-focused leader.
Alger, Stubbs and Doig understood that the way they were currently measuring their customer profitability was incorrect. They developed the following goals for the project...
- To shift the focus from the belief that the company sells pounds of aluminum to one that sells time and expertise on extrusion presses.
- To determine whether profit velocity could differentiate customers into ‘value subgroups’ within the portfolio;
- To create Customer Value Management strategies that focus on individual subgroups within the portfolio designed to…
- Optimize revenue per unit of manufacturing time
- Increase customer value,
- Increase profit.
- Extruding aluminum is much the same as working with play doe. The idea is to heat an aluminum ingot and drive it through a die sometimes called a shape.
- Extruded aluminum is in everything from ladders, to window frames, to truck trailers.
- Extrusion plants historically were located close to their market to minimize shipping costs, which was the reason Indalex had 19 plants across North America.
- The quality of the aluminum can range from very basic, found in ladders to a highly finished work of art that you find in products like high end audio speakers or Apple computers.
- The business is cyclical, busier in the summer, as a result of the need for more building products than in the winter.
- The slower the extrusion process the higher the quality.
- The shorter the run the higher the waste percentage.
- The business is for the most part very price competitive and to be successful the extruders have to be constantly running. Uptime, speed, yield and margin are the classic measures.
- Extrusion companies historically try to optimize machine time by running the machines as fast as possible, minimize die change time and run long batches.
- The best product was an easy, fast product to run. Even though a high quality, slow running product paid a hefty price the margin was often just so-so.
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1 Both Indalex and Alcoa’s extrusion group are now owned by Sapa.
2 MANAGING; Will This Customer Sink Your Stock? Here's the newest way to grab competitive advantage: Figure out how profitable your customers really are. Larry Selden and Geoffrey Colvin. Fortune Monday, September 30, 2002
3 Mike Alger was just appointed Group CFO at Sun Capital Partners
4 Managing a business as a portfolio of customers, Mike Alger, STRATEGIC FINANCE, June 2003
5 Tim Stubbs was just appointed world wide President of Sapa.
6 Mark Doig is currently Director, Strategic Sales & Marketing for Sapa North America
Chapter 2
The Extrusion ProcessAn extrusion plant uses very large machines and in some cases very high tech equipment, but it is a surprisingly simple process. It takes in raw material in this case an aluminum ingot and produces money by selling the products it makes. Each extruder is really a money machine. For every minute it is running it is generating revenue. However, depending on what it makes it is not always generating the same amount of revenue.
To make money in this business you have to be able to drive revenue through the extruders above what it costs to buy the raw material, make it and sell it. Pretty straight forward.
Indalex’s financial system was based on product margin. The margin however did not effectively take into account the time that the extruder ran. This is the same story as Rhone Poulenc’s Alchapaste.
The Management team instinctively knew that they had products at both ends of the extreme...huge resource hogs which on paper did not look like good business and at the other extreme, very high volume, very low margin products that the organization was seriously thinking about walking away from.
Should they really do this?
In a recent breakfast I had with Mark, he postulated that the key reason that this project was so successful was that his team had already come to the conclusion that the way to deliver value to the customer was to have substantially better understanding of the current profit picture by measuring and then managing their processes differently.
As a consulting aside...we can only go as fast as our clients can manage. Certainly one of my frustrations has always been... ‘Come on guys! Don’t you get it!‘ Well these guys got it.
The Bull's Eye Program
The Bull's Eye program is based upon a 7 step structured process. In the next section I will describe each of these steps. Although I have layed out the process in a linear way, naturally, it didn’t quite work that way in reality.
Phase 1 Crystallize the Vision
The team had come to realize that extruder time was the critical measure in making money. However, it was no longer simply about running faster it now became how to run profitably; more profitably; and, ultimately most profitably.
Their vision to meet the new growth target was...
...to operate the business not as a collection of products, services, and assets, not as a group of territories, but as a portfolio of customers that can be managed in the best interests of our company and our customers alike.A transformation of this magnitude doesn’t happen in one meeting. Alger, Stubbs and Doig had been working and thinking about this for about a year. They had done basic profitability models, now they were ready to pilot the new concept. If it worked as they hoped, they were ready to drive the implementation as fast as possible.
Phase 2 Craft the Strategy
It was decided to begin the program with one plant - Mississauga Ontario. This was a perfect pilot project. The extrusion business is essentially geared to local customers and each plant had its own marketing and finance departments. 90% of the customers were located within a 400 km radius. The goal for the pilot project was to analyze the implications of moving to a time based costing and profit system within one region.
To move from a vision to an implementation plan obviously required a strategy that would be linked to the implementation of the pilot project in Mississauga. At this point there were more questions than answers.
These are a few that the team had to struggle through...How would the marketing team accept new measures? How would cost be measured and calculated? What would we do with the information once we had it? Assuming that we came up with customer segments how would we organize to manage those segments?
We started with the Strategic plan and modified it to be consistent with this new endeavor. The management team had put together profit targets and operational cost improvement targets in their new strategic plan and these targets needed to be integrated into our program.
For instance using the following assumptions...
- A target margin of $2.5 million
- The planned machine uptime for the plant was predicted to be 7000 hours. (80% of 24x7x365)
- The plant had 4 extruders (for this example assume they are all the same)
- The ‘hurdle rate’ is the average margin per hour that must be generated. In this case $890 /operational hour
We were ready to move.
Phase 3 Capture the Value - Focus on Measurement
What we needed was new calculations for the cost system based upon extruder utilization. This actually made the costing process much simpler. We could create a cost per unit of time (using the annualized target for total time) and margin then became cost over extruder time.
Indalex already had an excel file with extrusion time for each product. As a result it was relatively easy to develop our profit velocity calculations for each product.The chart on the right was the prototype used for analysis.
We set out to plot the status quo of all customers from the one plant across 3 dimensions...
-> volume,
-> full margin, and
-> profit velocity,
This kind of analysis would allow us to compare the old information to the new data.
There is a common, although often unstated belief that the hurdle rate (the average $/hr needed to generate profitability) is really a bit parabolic, a declining curve based on volume.
Obviously it costs less to make 10 things instead of 1 in any organization that requires set up and cleaning. Therefore profit velocity should go up with longer runs not down. However, some short run products can also generate high profit velocity if priced correctly. One needs to think about this concept as the outcome to many levers. I will present an example later of how the organization learned to manipulate these levers and the financial impact it had.
The target hurdle rate is not a fixed number. If the organization was to lose the business represented by the little dot on the lower right hand part of the above chart AND not fill the available time, the hurdle rate would go up to cope with the extra burden the remaining products would carry.
Phase 4 Measure the Current Customer Value
This is the 4th phase in this project. The team had a vision of where they wanted to go, had put their strategy plan in motion by developing a first look at profit velocity analysis for the Mississauga customers.
The composition of the team was critical and it was a clear message as to how the management was thinking.
One of the big problems I have experienced in many organizations is the lack of interaction between marketing and manufacturing. In some cases marketing is so far removed from manufacturing that they really don’t understand how their product is made or more specifically why product A is fundamentally different from product B. Manufacturing often has no idea why the customer asks for certain special requirements, they just do it.
This phase was designed to bring understanding at a multiple of levels to why a current product / customer had... Bad? Good? or Great?
Profit Velocity
The levers of change using this program are fundamentally different and more copious than simply looking at the profit of a product by margin. This is the difference between a static analysis filled with averages and an analysis of what is really happening to this product. How do those special requirements impact profitability.
This, then is a huge benefit to the marketing people in that the data set now gives them many more weapons to drive profit than just fighting over price. Product manufacturing cost is driven by a plethora of issues, such as order size, response time, special packaging, special materials, special transportation and on and on. These special requirements create value that may or may not really be required. Now if a customer wants more value he can negotiate to pay for that value. Likewise if the organization can remove extraneous cost factors without affecting the customer, profit velocity goes up.
We planned to have two initial meetings. We needed to get as many people thinking along this new vision as possible.
Introductory meeting
The goal for the introductory meeting was informational.
Alger laid out his plan to move this organization to a time based model. We explained our concept of the extruders being money machines and we needed to get a much better handle on how they worked.
Our plan was to involve this group in both the analysis and the plans for change. We scheduled a meeting in two weeks and we gave the participants a task...
Sort a group of customers that we provided by their profitability from high to low.
We told them that we would do the same analysis using our new model and provide some data for their review.
We didn’t get any accolades from the participants. But on the positive side we didn’t get any pies thrown at us either, but I think that it would be fair to say the majority of people thought this to be another hair brained flavor of the month.
Our plan was to meet again in two weeks for an entire day and discuss the analysis.
The Data Presentation Meeting
Two weeks later, we presented the chart at the left, a measure of the status quo for the organization.
Each of the ball’s represents a customer across the 3 measured dimensions.
- volume (left to right),
- full margin (size of ball),
- profit velocity (the height of the ball)
We didn’t tell the group which customers were measured by which ball. Their task was to try to guess.
For over an hour the group argued until they reached a consensus and presented it to us.
We then overlaid our analysis and the results dumfounded the group. They were wrong more often than right and they couldn’t recognize the portfolio group patterns. The mood had shifted. The group understood the rationale for change which was critical to the success of the project.
We spent the rest of the day looking at individual customers and discussing issues that drove profitability. This discussion wasn’t always how do we improve. There were several very profitable customers that the team discussed key customer value management strategies that would insure their retention.
They definitely wanted to see more, to understand how this information was calibrated and most of all what new leverage they had to affect change.
The management team had some work to do and agreed to meet in two weeks.
Chapter 3
Phase 5. Creating Value Groups
What did the natural customer value group patterns look like? and, How much leverage could the team really develop?
Did the organization have the right people to move from a focus only on individual customers to a focus where each customer is also a member of a distinct portfolio?
It is one thing to profess that the costing system is inaccurate and another to see that the people making key decisions that affect the organization’s profitability could not determine which customers were deeply unprofitable.
The Management of Indalex was confronted by the fact that their customer strategy--their whole plan for acquiring, maintaining, and developing customers was deeply flawed.
The Indalex team clearly didn’t understand its customers in terms of how they created or destroyed value.
How do you engage with your customers to drive up their value? How do you manage customer value?
We were about to learn.
To ground people in this task, we needed a definition for customer value management which would recognize and focus on the fact that we had different portfolio’s of customers with different needs. The following is what we presented to the task force.
The Customer value management project has two basic goals:
- Deliver the transactional level of value to targeted market portfolios and their customers.
- Get an equitable return on the value delivered.
(Transactional value is derived from the customers needs for product and service)
I.e. don’t try and sell me a Porsche if I want a Ford Taurus.
The senior management team arrived quickly at two key decisions. The first decision was that the lead for the project would now move from the finance group to the marketing team with Tim Stubbs taking over the sponsorship. The second decision came out of looking at how to manage customers within the proposed portfolios.
Frank Lloyd Wright, the famous American Architect coined the term Form Follows Function.
The reason that the organization had not understood the implications of poor portfolio management was that the current structure had no portfolio accountability.
Stubbs realized that to move the organization forward he needed to create functional accountability for managing these portfolios - which initially meant a realignment of the marketing group in Mississauga from a being focused on an unrelated group of single customers to a team responsible for one of more portfolios. Later this would include moving some accounts out of the plant and into a national portfolio.
Phase 6. Creating Customer Portfolio’s
The company made products for sectors such as...consumer home products (ladders etc.), doors and windows, specialty consumer products requiring very high quality (speakers etc.), the construction industry, building industry (moldings, finishings), marine hardware (docks, boat fittings), industrial products, truck trailers, the automotive industry etc.
When the profitability analysis of individual customers was incorporated into portfolios it looked like the chart above.
Team Structure
The teams were made up of newly created portfolio managers and supported by resources from Finance and Manufacturing.
The tasks for each customer portfolio team were to...
- Understand how value was created for each customer within the portfolio.
- Develop customer value strategies to move the customers in an appropriate positive value direction.
- Work with the customers to implement the new value strategy.
Creating Customer Value Portfolio Strategies
At this point in the project ‘the rubber hits the ground’. The task was to look in depth at each of the customers within the portfolio’s. What is causing some of our customers to be profitable and others not?
For this discussion I have provided two examples of the kind of analysis that the group went through.
The goal for each portfolio analysis group was to move the majority of customers above the hurdle line and into the profit zone.
The example to the right shows a group of customers who were believed to be very high value customers because their margin was positive, but who turned out to be, for the most part, generating below average profit velocity. The implications of this discovery was a matter of great import. Suddenly the team was confronted with the fact that the manner in which they should relate to these customers was dramatically different. The initial response was confusion. The team needed to find out why these customers actually didn’t generate profit.
The cross functional team assembled to diagnose the reason for the status quo, develop strategies for change and then to problem solve.
What differentiated the two customers above the hurdle rate from the mass of customers below?
Pricing and margin were basically the same but the true profit picture was fundamentally different.
Why?
In this instance the problem wasn’t pricing, it was run size. The group below the hurdle rate had very frequent and relatively small orders designed to drive a just-in-time order strategy. The result of this was that yield was substantially lower and freight was higher given the small run size.
This analysis process creates a fundamental change in problem solving within the organization. Instead of only one lever which is pricing, now the group had many. Instead of the usual finger pointing between functions where more energy goes into trying to pass off the problem, these multi-functional teams began to look at options that could be discussed with the customer.
Once they had a plan they would meet with the client and propose changes to improve profitability.
The example crystallized the issues of customer value management. CVM no longer was an esoteric concept to the team. By providing certain customers with smaller run sizes and more frequent deliveries the true cost had gone up dramatically and therefore the margin per extruder hour was substantially lower.
The realization that the lowest of this group was really draining value was stunning.
What surprised me was the sense of purpose that the marketing people developed. They were the point men and women. We had given them a problem and they saw it as a challenge. Their role from a Value Management perspective was to work with the customers to change the order patterns. An increase in run size would reduce scrap and increase production speed, which would have a substantive impact on profit velocity and therefore customer profitability. Ultimately if this was impossible the customer would be ‘pushed away’ to one of the competitors.
Did I mention, that the management team planned to align the compensation system to the new targets with the result that the bonus system was to be linked to customer profitability?
There is a story about how one portfolio manager handled one of Indalex’s customers that I always thought was folk-lore until it was proven true. Through this analysis the manager came to realize that one of his customers was really a huge drain on profitability. After trying valiantly to work with the customer the conclusion was that serving this customer was not in Indalex’s best interests. The story goes that the portfolio manager met one of his competitive colleagues who worked for Hydro at the Greenville plant in South Carolina. He handed the customer’s card to his competitor and ‘gave him’ the business. I always thought that this was really an embellishment until I worked with Hydro and told them the story, where upon they immediately knew who the customer was and bemoaned the acquisition.
Analyzing Distributors
This new marketing portfolio manager and team were given an onerous task.
It was not news to the company that margin was low, but because order sizes were so small profit velocity was very low. The question that came out of this process was why do we keep this business?
The task for this group was to significantly improve the profitability of this portfolio.
What the team realized was that for the most part these ‘distributors’ were ordering product in very low volumes based upon sales that they had already made. For instance in the aluminum windows and door market, they would order product that they had sold. As you can see the profitability on this group was awful. But this doesn’t describe the breadth of the problem. Somehow, the distributors had convinced the organization that they were critical. They demanded high service levels, asked for short lead times, and made special technical requirements a normal part of the interaction.
This had to change.
The team decided to reduce the number of distributors dramatically. In doing so the team had to select the distributors that the company felt that they could continue to do business with and then negotiate new service level terms based upon pricing, order sizes and an overall significant increases in volume. The strategy was to move this group up and to the right of the chart, by increasing pV through larger run sizes and higher volume.
Over a period of 6 months the number of distributors was drastically reduced, while the remainder became significantly more profitable to the company.
The Mississauga plant thrived under the new strategy that was supported by new metrics. Now the question became how do you take a successful pilot and move it across a large number of plants?
That question is coming in the next installment.
Chapter 4
Creating A Customer Value Culture
One of the problems in any large scale change is to create a cultural transformation that makes change stick. You can pretty much do whatever in a part of the organization if enough energy and force is applied.
The problem is that once the consultant has left, the organization will quickly revert to its old ways.
I am a great admirer of Sun-Tzu the great Chinese General, who is considered one of the greatest strategic minds of all time. His book is a primer in all military colleagues and most graduate schools for the development of strategy. It seems that at this point of my journey it might be appropriate to use some of his enlightenment.
To Sun-Tzu, the foundation of any strategy comes from information...you must know both the enemy as well as your own strengths, weaknesses, desires, timeframes and vision. He used spies to evaluate his enemy and created a formal structure to provide him with information. He also imposed a level of discipline that most modern organizations would envy.
Sun – Tzu….
If you know the enemy and know yourself, you need not fear the result of a hundred battles.
If you know yourself but not the enemy, for every victory gained you will also suffer a defeat.
If you know neither the enemy nor yourself, you will succumb in every battle.
Once Indalex began to dissect its customer portfolios in a way that opened up the opportunity for new knowledge, they were able to take huge steps forward in creativity and customer management.
The Truck Trailer Market
The truck trailer business is that tiny circle at the lower right quadrant.
Product was produced at several other plants across the country to minimize freight. The other plants showed a similar perspective on volume and margin.
This was a commodity business and raising prices was not seen as an option. The reason the pricing was so low was that it was the outcome of a fiercely competitive market.
Indalex believed that the competition was eager to grab this volume. It seemed that they just weren’t as willing to lose money.
At the beginning of the project there was active discussion of dropping this business. What to do with it?
Initially each plant was looking at this product group as its own portfolio. Naturally the teams from different plants began to converse and problem solve. The analysis created a new level of problem solving that had never occurred before. The data was very different across the plants. As a result the organization could not only compare the product data by plant profit velocity, but they could analyze why this occurred.
The problem of poor yield and high operating costs was the result of each plant trying to address the unique operational issues associated with these products, but without major capital they were very limited. But, at one plant in Indiana, near Chicago these issues were less problematic. This plant was configured in a somewhat different manner with different equipment capable of handling the very long bars that make up the 4 corners of the trailer. For this plant the profit velocity was just below the hurdle rate line.
The group determined that with a small capital improvement in the overhead crane and elsewhere, handling time could be reduced substantially with the result that cost could be significantly lowered raising the profit picture dramatically.
A decision was taken to consolidate this business into one plant. This was a fundamental contradiction to the classical way that extrusion plants were run. Would freight costs go up? Would these costs remove the advantage of the one production plant? There were more questions than answers.
However, with their new-found capabilities for analysis they quickly determined that this strategy made sense.
The decision then was to transfer all of this business to the Indiana plant and make it a ‘specialized’ producer.
Gross margins were improved by three per cent; packaging costs were reduced by more than $1 million; and freight costs were cut by more than $300,000. With this strategy, the product line went from a negative margin to being very profitable and Indalex was able to grow this business.
The results of the initial intense customer analysis was an increase in market share by 2%, a reduction of unused capacity by 38% and a volume increase of 80M pounds (36 000 tons) with an overall increase its profitability by US $20M.
Not too shabby.
Achieving a bull’s eye with a gun or an arrow is both art and science; requires both finesse and strength; necessitates the capability to both adapt to various conditions and yet be extremely decisive. It requires the discipline to keep refining the process and a feedback mechanism to drive the refinements.
Two examples of this capability for continuous learning are...
- the analytics team under Marc Doig developed ever more sophisticated models that targeted different hurdle rates in the winter months when there was available capacity and in the spring, summer and fall when capacity was very limited.
- One of their largest customers had gone to the market to improve competitiveness and was seeking a 10% price reduction. Historically the response would be to concede on price and take a haircut or walk from the business. Using their newly developed profit/cost intelligence they structured a new offering with discounts based on changes in alloy, increased order quantities and changes to pricing methods. Even with the 10% reduction in price, according to Mark, Indalex, now Sapa, was able to more than double the profitability ($/press hour) due primarily to the improved productivity and yield. Win-win for both Sapa and the customer.
