The Importance of Contribution Margin Reporting In Digital Transformation

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Digital Transformation As A Management Challenge

Since the publication of Ismail Salim’s groundbreaking book ‘Exponential Organizations’ in 2014, companies of all sizes have become increasingly aware of the need to adapt to a fast-paced rate of disruptive technological change. It has become commonplace that it is just a matter of time until even in the most traditional industries current business models will be disrupted by advances in artificial intelligence, robotics, 3D printing, nano-technology and the like. Digital Transformation has emerged as a term to describe the conscious management effort to adapt organizations to this new business environment.

Digital Transformation is much more about cultural change than technology adoption.

As Stanford University Professor Pamela Hinds pointed out in her webinar ‘How to lead [and not just survive] Digital Transformation’ this week, digital transformation is much more about cultural change than technology adoption. In order to lead digital transformation, she concluded, organizations need to become more customer centric, open-minded towards change and decentralized in their decision-making.

Empowerment And Accontability: The Two Flipsides Of The Coin

As a business leader you might ask yourself how to bring about this cultural transformation without jeopardizing managerial control and business performance. Decentralized decision-making sounds well but coherence and consistency with established rhythms, processes and policies generate economies of scale that most businesses will continue to depend on. And how do you measure what works and what doesn’t? 

Decentralization of decision-making without doubts needs to happen within boundaries. Even in companies with a strong cross-functional, collaborative culture, there remains the need for a hierarchical chain of command that sets the limits of discretionary decision-making power on the lower levels. The more you relax these limits throughout your organization, i.e. the more you empower people to take decisions for themselves instead of asking for approval from their superiors, the more critical it becomes to hold them accountable for the outcomes of their decisions.

Empower people to take decisions by themselves instead of asking their superiors for approval.

In The End, It All Boils Down To Contribution Margins

Leverage customer proximity and unleash innovative potential at the base.

So how do you hold teams at the base of your operation accountable for their decisions? No matter what the strategic objectives in the short term, at the end of the day, all businesses need to deliver profitable growth. Their ability to generate free cash flows is what they get ultimately measured upon by investors, regardless if startup or Fortune 500 corporation. Profitable growth is a function of sales volume and operating margin. At the lower levels of an organization it can best be approximated by the so-called Contribution Margin, the flow of operational profits that contribute to covering fixed costs that cannot be attributed to any specific operation, say expenses for overhead functions like HR, Finance and Legal. In a commercial context, sustained expansion of contribution margins is what you would want to measure your teams on. This way you can leverage their proximity to customers and unleash their innovative potential at the base while making sure that incentives are aligned with the overall objective of the company: to generate profitable growth.

The difficulty now is to measure contribution margins adequately on lower levels of your organization. Most management reporting systems do not provide a drill-down of all relevant costs or allocate them in an arbitrary manner. This is where the ‘digital’ part comes back into play. The adoption of advanced analytics and instant visualization tools can help companies establish managerial reporting capabilities that are fully automated and disseminate real-time financial performance indicators down to the sales manager or even customer account level. Team members will see the financial impact of their actions almost immediately and can experiment (within established boundaries that is) in order to find smarter solutions for their customers’ needs.

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