Finding Hidden Profit Through Quad Analysis
by Peter Philippi, CEO | ABOUT PETER
Two of the most valuable and revealing tools that we use routinely in our 80/20 practice at Strategex are Quartile Analysis and Quad Analysis. So, what’s the difference?
Last quarter, we talked about Quartile Analysis and how it can help you quickly discover your “best” customers, purely by sorting customers by sales. This quarter, we’re diving into the data a little deeper using Quad Analysis, a tool to help you discover which areas of your business are most profitable — and which are actually costing you money!
After completing your company’s Quartile Analysis you will see that your business is primarily driven by those top customers and products or services. Almost without exception, our clients discover that they have products, lines, services — even customers — that add little value to their top line, and cost them money at the bottom line.
After doing your own Quartile Analysis, you have in all likelihood found yourself in a similar situation. And you probably have some nagging questions:
- What if some of my low value products/services are bought/used by my best customers? Won’t they take their business elsewhere if I fail to meet their needs, or raise the price?
- And what about my small customers that buy the products/services I sell most often — shouldn’t I be driving those sales?
This is where Quad Analysis comes in.
The breakdown: where’s your profit hiding?
Essentially, Quad Analysis splits up your company’s revenue into four “Quads” which are broken down by customers and their spending. For the purposes of this exercise, we will break your customers into two categories: “A” customers, and “B” customers, and your Products and Services into two categories: “A” products/services and “B” products/services. The “As” are the critical few customers (typically 20%) who account for a whopping 80% of your revenue (the “80s”). The “As” define your business, because without them, you don’t have enough revenue for your business to survive. The “Bs” (or insignificant many), on the other hand, provide a small amount in sales. These are the majority (80%) of your customers who provide only 20% of your revenue.
We suggest using revenue because profits tend to have incorrectly allocated costs included. For example, if you only had to service your top customer, the amount of employees, space, and machinery needed would require much less overhead than is currently allocated. If your company has high material or labor costs, you can break out your 80s by direct margin, just be sure that only direct costs are being taken out of revenue.
Now on to the Quad Analysis: start by segmenting your A and B customers and products/services into these four Quads:
- Quad 1: “A” customers purchasing your “A” products/services — “80s” buying “80s”;
- Quad 2: “A” customers purchasing “B” products/services;
- Quad 3: “B” customers purchasing “A” products/services; and
- Quad 4: “B” customers purchasing “B” products/services (all garbage in this one!)
What do your four Quads tell you about your revenues? You will find roughly 64% of your revenue in Quad 1 (80% X 80%), 16% in Quads 2 and 3, and a measly 4% of revenue in Quad 4. But, much more revealing is how the profits fall in these categories.
Get to know your Quads, and where your company is hiding profits!
Quad 1: We call Quad 1 "The Fort." This is the segment of your company that must be protected and grown. It is about 64% of your revenue — it’s highly strategic and has great growth potential.
If you were to put together a P&L on this segment alone, allocating the actual overhead required to run as a separate business, you would find over 100% of your company’s bottom line is found here. Most often we find 150-200% of a company’s profit in this Quad! How can that be? It’s because you are losing money and perhaps only breaking even in the other Quads.
Quad 2: Your “A” customers are always going to buy things that aren’t your core (some only buy “B” products and services). This is Quad 2 business, or what we call the “Necessary Evil.” It’s typically about 16% of your revenue, and tends to be around break-even at the bottom line. This segment requires a lot of support without much revenue to cover it. It doesn’t boast good margins, either — your best customers tend to drive a hard bargain!
There are plenty of ways to minimize the losses here. You can raise prices — even on your biggest customers. There is risk, but you will only raise the prices on “B” products, and lower their prices on the “A” products/services they buy. Most likely, they buy more of your “A” products, so the deal is good for them, and good for you.
Your “A” products and services are 150-200% of your profits; you have room for pricing with these “A” customers buying “A” products. Lowering the price to promote a Quad 2 to 1 transition will only enhance your business. The “B” products and services are done much less frequently, so your chance of making a mistake is much higher, and you aren’t making any money on it because of the complexity it adds to your business. If pricing isn’t an option, talk to the customer and understand their needs. The conversation alone will better prepare you for serving that “A” customer, and understanding their needs from your business.
Quad 3: “B” customers buying your “A” products/services. These are the customers that only use your best products/services, and they make for very good business.
This business is called Quad 3 business, and it is typically 16% of your revenue as well. The Quad 3 business requires lots of transactions, and steals resources from the “A” customers and products/services, but the items/services are standard. Quad 3 can be great if treated as a separate business – these customers are not your “A” customers, and should not be treated as such.
Policies should be put in place to keep this business standard. We recommend treating this Quad as “distribution.” It can either be sold to distributors or outsourced for fees, or this can be treated as a separate business within your business. Put policies in place to make these small customers profitable. For example, require minimums on orders with cash up front (no credit checking, issuing POs or invoicing), and no specialty service (without a price). Manage the overhead needed for these customers separately from the Quad 1 and 2 businesses to ensure this Quad is profitable.
Quad 4: Revenue from Quad 4 doesn’t add up to much — only 4% of your total revenue — and it requires a lot of overhead support, involving many and varied complex transactions.
If you put together a P&L focused on the resources needed for a Quad 4 business, the results would show a very large loss of profit! Growth never comes from this segment, making it entirely non-strategic.
So, what do we do with a small, transaction-laden, overhead-needy, unprofitable, and completely non-strategic Quad? 99.9% of the time, Quad 4 and the overhead associated with it can be eliminated, allowing you to find the profit hidden in Quad 1. Without the time, energy and resources used in Quad 4, you could refocus your energy on Quads 1 and 2 — which up until this point were lacking support. Just by eliminating Quad 4, your company would immediately show financial improvement!
Find answers through analysis
Take a hard look at your four Quads. What can you do to grow Quad 1 and keep its profits? What can you do to scale back Quad 2, and eliminate Quad 4 without compromising your reputation or business?
We can’t stress enough how vital Quad Analysis is, both in terms of revealing truths about your business and giving you strategic direction. You can easily perform a Quad Analysis in Microsoft Excel or Access. So, while Quartile Analysis shows you how your company’s revenues are imbalanced, Quad Analysis will show you where your company thrives strategically, and where it can use some work.
Remember: it’s not that you aren’t making money. The problem is that you are not keeping it. Quad Analysis is critical to your business, and can be used with any metrics — customers and vendors, or customers and sales people. The possibilities are endless. With just a few cuts of your data you should be able to improve the profitability of your entire business.