WORKSHEET #26: Identify the Profit Increase from the Improvement in the Mix of Customers

Step 1:
Begin with the results from Worksheet #11: Customer Categories and Objectives. This worksheet places each current and potential customer into one of the three types of Core, Near-core or Non-core customer, along with the expected operating margin on each customer or customer type.

Step 2:
Estimate the change in the Company’s Return on Investment due to the change in customer mix as follows:

• Calculate the average current and expected EBIT on each customer or customer type.

• Calculate the current weighted average EBIT using the following table.

• Use your estimate of total future sales at the close of the future period to calculate the new weighted average EBIT, using a table like the one above. Note that you may need to adjust your expected sales and EBIT for the effect of any expected changes in prices and costs. For the change in prices, please see your work from Basic Strategy Guide Step 19 and Diagnose/Pricing
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• Do similar calculations for current and future: Allocated operating profits (for business units), net capital employed (NCE) and profit after tax (PAT), as appropriate for the type of business you are analyzing.

• Using the calculations above and your future sales, calculate your future RONCE, ROA (for a business unit) and ROE.

Step 3:
Determine the cost gap the Company must still close to reach the financial targets set in Basic Strategy Guide Step 24. These calculations assume no changes in levels of assets or net capital employed as a percentage of sales, other than those due specifically to the change in mix of customers. If further changes in asset or capital employed levels are in the Company’s plans reflect these in the following calculations as well:

• Determine the change in Capital Intensity (i.e., Net Capital Employed divided by sales) the Company expects over the planning horizon:

  • Calculate the Net Capital Employed required to produce the sales to each of the types of Core, Near-core and Non-core customers.

  • Calculate the Company’s current Capital Intensity using the Company’s current balance sheet information. Alternatively, calculate the weighted average result of the Capital Intensity of sales made to each type of customer, using a table similar to the one above.

  • Determine the Net Capital Employed the Company expects to need to serve each type of customer at the end of the planning period.

  • Calculate the Company’s anticipated Net Capital Employed at the end of the planning period by multiplying the Net Capital Employed by type of customer by the share of each customer type in the total sales of the Company, using a table like the one above.

  • Use this projected Net Capital Employed (NCE) figure in the next calculation.

• Determine the increase in EBIT required to reach the Company’s return on net capital employed (RONCE) target:

  • The required EBIT equals the target RONCE multiplied by the future NCE.

  • The future expected EBIT equals (the future EBIT percent x future sales)

  • The EBIT shortfall, if any, is the required EBIT minus the future expected EBIT.

• Do similar calculations for required profit after tax and expected operating profits (for a business unit) if the Company is using a ROE or ROA measure as its financial goal.

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