Margins eroding as product and order complexity grew.
Profitable on paper, eroding in practice.
Kanthal - the Swedish producer of metallic heating elements, since incorporated into the Sandvik Group - had profitability issues the bottom line couldn’t explain. The result was positive, but costs kept rising and profitability kept falling. Production costs were stable; the growth was in the indirect costs - sales and administration - lumped together in one account as “overhead”.
The KPIs gave insufficient insight into what and where countermeasures should be applied. Which products were profitable? Which customers? Why did overhead keep increasing? Kanthal’s CEO engaged SAM to conduct an order-line profitability analysis to find out.
Interviews first, then the order lines.
SAM conducted a series of interviews with employees to clarify their activities and how those related to Kanthal’s customers and products: with particular attention to sales and administration, where costs had grown fastest. Using what the interviews surfaced, the overhead costs were allocated to the order lines they actually belonged to, and the resulting picture of profitability was analysed and presented to management.
This was done before Activity-Based Costing was a widespread method, the Kanthal work helped shape it. When Robert S. Kaplan and H. Thomas Johnson launched ABC in Relevance Lost: The Rise and Fall of Management Accounting, the Kanthal case was included, the start of a long collaboration between SAM and the book’s authors.
The “best” customer was the most unprofitable.
The analysis showed that 20% of the customers were responsible for 225% of the profit: and that the largest customer, viewed as the most important one, was the most unprofitable. Management introduced automated order handling for selected customers, turning them profitable without interfering with the relationships - slightly improving them - and used the report and analysis as a tool in customer relations.
The result was changed processes and changed behaviours, at Kanthal and among its customers, that kept contributing to profitability. The case is still taught in Harvard Business School’s MBA program, one of its most widely published cases.
