An alarming number of businesses of discrete manufacturing and engineering industries loose up to tens of thousands of dollars per year to eroding margins.
The term defines a loss of margin dollars that occurs once a sale for a product or solution with less than the expected margin has been completed. Consequently, it signifies a gradual reduction in gross profits over time.
For discrete manufacturing and engineer-to-order businesses this is especially relevant as the nature of their products and solutions is rather complex. Costing for these products is determined by multiple factors and miscalculations can have significant impacts due to high volumes, prices or long contract duration. In a globalized and highly competitive economy customers gain more and more power to challenge the prices and margins of manufacturers. In order to protect profits, manufacturing businesses need to identify potential and actual leaks and take counter measures as early as in the sales process.
What causes margin erosion in manufacturing industries?
Margin erosion can originate in various risk factors for manufacturing businesses:
- Production process risks
- Procurement of raw materials, components, and production facilities
- Risks associated with outsourced production
- Market fluctuations
- Fluctuations in foreign exchange and interest rates
- Rapid technological evolution
- Inaccuracies, miscalculation and inefficiencies during the sales process
In this article I want to focus on the profit loss happening even before production, which is when margins are calculated during the sales process.
Indicators for margin erosion to watch for
Following the principle of “You can’t manage what you don’t measure”, as a manufacturing business owner or CFO you need to monitor closely the key areas of operation that affect your margins.
Imagining your sales process as a pipeline, it is important to identify potential and actual leaks, follow up with the reasons and fix them. As a start, place a bucket under each leak to see how fast it fills, thus how much it contributes to your profit loss.
We have identified the following indicators for margin erosion in the sales process:
Headcount dedicated in Engineering for checking and completing proposals.
If you are looking for leaks in your sales, it might not be obvious to check with other departments. But if your engineering team sets aside specialists and engineering time to check and complete proposals, this needs to be added to the cost-of-sales and monitored closely.
Proposals with product and solution configuration and cost calculation take weeks.
Measuring and overseeing the time from lead (or opportunity) to deal closure is crucial as part of your revenue prediction calculations. But increased sales cycles also mean increased cost-of-sale that fill another bucket of lost margins.
Low close-rate for built-to-order proposals, lost or incomplete orders.
A low close-rate for built-to-order quotes can indicate a low quality of proposals or non-attractive financial proposals. In any case, it means lost profit and needs to be analyzed carefully.
A high number of proposal corrections.
Numerous versions or corrections of proposals can indicate a lack of quality in the customer requirement analysis, which can often be solved by an increase of customer-face-time. Eventually it can also direct to a low quality of the proposal itself. In both cases, the sales process is prone to margin erosion and uncovers inefficiencies that often result in a lowered customer satisfaction.
Actual costs exceeding the quoted costs.
Implement an ongoing controlling process comparing the actual costs from fulfilment and production from your ERP with the originally quoted costs and allocated margins from the sales team. How much of the margin is lost after deal closure?
Increased order correction costs and budget shifts.
Attribute order correction costs to the matching accounts and offset these losses against the margins. If budgets are being shifted from original allocations to newly identified in-scope efforts this often shows inaccurate planning or masks order correction costs.
How a Configure Price Quote (CPQ) system prevents margin erosion
Once you have identified the leaks of your manual sales process and implemented a measure and control system, you need more than a bucket underneath it to prevent further margin erosion.
The power of a Configure-Price-Quote (CPQ) system lies in the direct elimination of errors and inefficiencies. The software enables sales teams to swiftly produce accurate, professional quotes and proposals for every individual customer. Having a streamlined and much shorter pipeline lowers the entire cost of sales. Additionally a smart CPQ system presents predictive up- and cross-selling opportunities to increase deal sizes and empowers a smooth collaboration of sales and engineering and purchasing teams via automated routing and approvals.
These are the benefits you can expect from implementing a CPQ system:
1. Reduced sales cycle time through a streamlined configure-price-quote process
2. Efficient quote contribution of specialist parties like engineering and purchasing via workflow routing & automated approval processes
3. Increased deal value through custom-fit configuration and further upselling opportunities presented by a smart system
4. Avoided pricing and costing errors, higher deal margins
5. Avoided configuration errors, saved correction costs
6. Increase of customer-facing activities raising customer satisfaction
Going one step further, implementing a backflow of fulfilment costs compared to quoted costs can help the sales team to avoid making the same mistakes in future quotes. (Read more about our approach which directly connects the quotation process with ERP data to gain transparency over the cost, revenue and profit from quotation till production lifespan.)
Margin erosion for manufacturing and engineering businesses happens way before production - in the sales process. Due to the complex or configurable nature of their products and solutions, problems such as miscalculation, configuration errors, extended sales cycles and high order-correction costs reduce gross profit over time.
A reasonable CPQ system streamlines the entire configure-price-quote process and enables sales teams to create accurate, professional proposals for every single customer within hours instead of weeks.
With predictive up- and cross-selling recommendations and industry-specialized team collaboration features, smart CPQ systems empower modern businesses to increase profits even in today’s highly competitive and globalized markets.