Revenue risk is the potential for future revenue to be lower than expected. This can be due to external factors such as economic conditions, or internal factors such as product launches. To manage revenue risk, you need to understand how to calculate it. This article will teach you revenue at risk calculation methods.
By using these revenues at risk calculation methods, you can ensure that your business is protected from any potential losses.
Revenue at Risk Calculation
Why did so many companies fail in the pre-pandemic years despite having a formal risk management system? The problem is that many companies’ primary tool to assess risk is The risk heat map.
While the risk heatmap process looks at large, blunt risks such as hurricanes and sales force effectiveness, it doesn’t identify the more specific and immediate risk elements that could threaten profitability or even survival in today’s rapidly changing markets. The good news? transaction-based profit metrics can greatly improve your risk management effectiveness.
The traditional risk heat map
A risk heatmap is simply a map of the risk exposure of various business elements. The importance of an element is on one axis and the likelihood that problems will occur on the other. consider Coastal Distributors, a $650 million distributor of industrial products.
Opportunities for midsize businesses
- The success of a company’s sales team is crucial. its importance is high. However, its sales reps have a lot of experience and are well-trained, so there is less chance of problems.
- Coastal ships most its products through its network distribution centers. Because of this, its importance is high. However, if there were to be a problem in one facility, it could easily use another nearby facility to help the affected customers. the likelihood of disruption is moderate.
- The company employs technical representatives to assist its customer base and also uses an outsourcing service to supplement its internal staff. The vendor could increase its involvement, but disruption is unlikely.
Coastal’s risk map does not show that only 9% customers generate over 150% of their profits. many of these key decision makers chose Coastal because of its technical expertise. It also fails to mention that only 3% of their products make over 85% of their profits. these products are highly susceptible to supply disruptions.
The risk management team was also aware that additive manufacturing was a new technology where products are made from a powder-like substance, then heated to harden them. This is a different way of making products than using cutting tools.
They weren’t concerned about the market penetration of niche competitors that specialize in this innovation being less than 6% so they didn’t include it in their analysis. they didn’t realize that 12% of their products generate over 180% their profits and that the new additive manufacturing process would replace about one-third of these sales.
The company devoted time to its
Coastal then reported the results to shareholders and to the SEC in its financial statements. many of the most critical elements were still missing.
This is a vital issue for mid-sized companies that don’t have the resources or diversification to absorb potentially fatal risks.
The action question is how to integrate key profit-generating customer base, products and operations into a company’s risk management process.
We have previously written about transaction-based profit metrics in HBR. This innovative metric provides the missing element of risk heat map. Companies can quickly identify three types of profit segments when they use transaction-based profit analytics and metrics (creating an all in P&L for each invoice line).
These include “Profit Peaks”, their high-revenue customers that generate 150% of their profits; “Profit Drains”, their low-profit customers with a typical 30% to 50% loss (typically around 30% of these customers); and “Profit Deserts,” which are their low-revenue customers that only produce a small amount of profit but consume approximately 50% of the company’s.
The company’s revenue was stable, but the company’s profit was steadily falling. In response, the executive team instituted new transaction-based
One group of profit peak customers was happy with the company while another group was constantly upset. The difference was that the happy customers were located near distribution centers, while others were located outside the areas of distribution centers’ service areas.
The team discovered that the company’s trucks served the customer base closest to it, while distant customers were served via third-party carriers. the problem was caused by the constant turnover of these carriers.
their customer service surveys had gathered all customers, and the distant profit peak customers made up only 3% of all customers \(but 35% percent of the profits), so these average metrics greatly underestimated the severity and urgency of their problem.
The team devised special delivery routes for profit peak customers and created valuable, high-service services such as off-hours expedited delivery. The investment was well worth it in terms of customer retention and growth.
The company’s traditional risk heatmaps were not able to see the actual profit impact without transaction-based profit metrics.
We live in an age of increasingly fragmented and diverse markets. Different market segments have different pricing, costs to serve, profitability, and other factors. Your profit landscape is The starting point for risk analysis.
Protecting and growing your profit peaks is the most important risk management concern If 20% of your customer base or products generate more than 150% of your profits. The heart of risk management must be a thorough analysis of which customers and products fall within this segment and what changes would threaten or enhance their performance.
It is vital to monitor each profit peak customer’s or product’s profit erosion and growth, as well as periodically scanning for specific threats external or internal to their performance.
Next, you need to assess your profit drains and track them to determine if they are increasing or decreasing. If they are growing, you will need to devise risk mitigation measures to reverse that trend or consider repricing the relationships to compensate.
Your profit deserts are many and have low profit per product or customer. They are almost insignificant to your overall profit production unless they have a huge impact on large numbers. you need to be able to identify which ones can lead you to your next profit peak.
This basically changes the traditional analog risk assessment that focuses on broad risk management to a digitally focused risk assessment that focuses on your contours and profitability. This makes your risk assessment more actionable and comprehensive.
The majority of a company’s core business elements, such as branches, sales reps and products, are located in the same profit segmentation pattern. You can use the same profit segmentation pattern to replace your risk heatmap with a profitheatmap that clearly and comprehensively displays profit-erosion risks.
A profit contour is a useful configuration for risk management. It’s a matrix with the customer profit segments on one axis and product profit segments in the other. similar profit contours can be created for customers, products, sales reps, and other important combinations.
Austin Associates, which is not its real name, has 40 stores and more than 120,000 products. The company’s management team focuses its
Profit peak product categories in profit-peak sales stores
These high-profit areas in Austin’s high-profit stores generate approximately $350 million in revenue and $44 million profits. As it is the fastest way to increase profits. The most important objective of the company is to monitor and grow This profit segment. It’s also to analyze and respond to any potential risks as soon as they occur.
The high-profit product categories that generate $175 million in revenue and $14 million in profit in Austin’s low-profit shops are responsible for $175 million in sales. This profit segment generates moderate revenues and moderate profits. The business objective is to increase the high-profit products, while shifting resources away the low-payoff product and monitoring for any risk that could threaten this profit flow.
Low-profit stores have lagging product categories that contribute $120 million to revenues, but lose $5 million. The primary objective is to redeploy resources in order to increase company profit peaks. It is counterproductive to be close to the risk management without carefully monitoring profit peaks.
Profit peak stores
These high-profit stores have a group of lagging products that contribute approximately $410 million in revenue but only $6 million in profit. The goal is to manage product mix aggressively to increase the share for high-profit products and to direct marketing resources towards the higher-profit items. close risk monitoring is not necessary here.
A closer look
The team was struck by these remarkable results and decided to add another dimension to their analysis — their highest-profit customers versus those with the lowest profits.
Profit maximum customers and prospects
This group of customers generates strong revenues of $460 million and profits of $97 million. It is important to note that even low-profit products purchased by these top customers generate strong profits. This customer group is a mix of all the product-store segments mentioned above.
This customer segment is being targeted to make a significant shift in company resources. This is the fastest and most secure path to profit growth for a company, and it requires constant risk monitoring and avoidance. any erosion in this profit stream must be addressed immediately by the company.
Profit drain and profit desert customers
This customer group is a major profit sink that requires intense attention. It generates $450m in revenues, but loses $40m. The primary goal is to move resources away from this group and redeploy them in order to grow profit peak customers. inadvertently soliciting customers that will end up in this segment is the primary risk.
Key to Success
Austin’s profit metrics reveal that account selection and management are the most leveraged processes for the company. It is nearly insignificant to reduce store operating costs relative to nurturing the right customers. Any risk factor that could jeopardize the growth and protection of profit peak customers should be identified immediately and managed aggressively.
Managers must incorporate potential changes in the industry and competitive landscapes into their profit segment objectives. your profit landscape must be the starting place for risk management in all cases. Each company has its own profit segments, each segment requires a different set of objectives and activities.
This will make a huge difference for midsize businesses with limited resources. They will be able to focus their competitive positioning on the most profitable, defensible markets segments in the near-term, and for many years to come.
If you’re looking for ways to keep your business safe, revenue at risk calculation methods are the way to go. By using these methods, you can make sure your business is protected from any potential losses.