Chapter 6: Business Segmentation

A segment is a component of a business that is or will generate revenues and costs related to operations. Financial information should be available for a segment's activities and performance and must also be periodically reviewed by the company's management before a decision can be made regarding the amount of capital that will be given to the segment for a particular operating period.

                                                                                                                Source: Investopedia

Quite big definition. I have a smaller one, easy to remember and simple to understand. Definition is ‘Divide and Rule’. This chapter is specifically for those businesses which are

• Involved in producing different types of products and providing different types of services
•  Doing business in different geographical location
• Type of consumers- e.g. retail and wholesale, consumers in different age group etc

By and large these are the only two basic criteria on which a business can be segmented. Rest all types of segmentation are just different versions of above two. Let’s take an example of a company in FMCG sector.

Company A is in FMCG sector. Its product portfolio includes bathing soap, shampoo, biscuits, juices, chocolates, fairness cream, shaving cream and dishwash bar. This business can be bifurcated into three segments.

Company A can measure performance by analyzing profitability of these three segments.

Fig in USD Mn

Particulars	Food Items	Beauty and Skincare products	kitchenware product	Total
Sales	150	600	750	1500
Direct cost	80	450	800	1330
Direct cost % to sales	53%	75%	107%	89%
Gross Profit	70	150	(50)	170
Gross Profit % to sales	47%	25%	-7%	11%

11% of gross profit on a revenue of USD 1500 Mn. Now if management wants to find out ways to increase profitability both in terms of margin percentage and absolute margin numbers it should drill down in to segments.

As you can see in above pie chart kitchenware products contributes to 50% of the company’s total sales, but if you look at the gross profits of each segment this segment is eating into company’s profits. If company A abandons this segment, scenario would look like this

Particulars	Food Items	Beauty and Skincare products	Total
Sales	150	600	750
Direct cost	80	450	530
Direct cost % to sales	53%	75%	71%
Gross Profit	70	150	220
Gross Profit % to sales	47%	25%	29%

In the new scenario the sales has come down to USD 750 Mn but now margins have improved both in terms of absolute numbers and percentage. Now among the two segments food items segment is much better in terms of percentage but that does not mean that the other segment should be abandoned. Although the gross margin percentage of beauty and skincare segment is lower than food items segment, in absolute terms this segment is generation more gross margin. Beauty and Skincare segment is in mature stage (Chapter 3: Life Stages (Part 3)) because of which the volume of gross margin is quite substantial.

This segmentation helps management to find out area which needs more improvement. Management can find out which segment is helping the company to compete in the market. E.g. Harley Davidson in its early stages to face competition from one its major competitor Indian Motorcycle introduced vehicle for mail delivery apart from its main product.

Divide and Rule is very old strategy which was used in wars but its useful today also that too in business.

Chapter 5: Shared Service

‘Sharing is caring’….that’s not the concept in corporate world. ‘Sharing is cost saving’ that’s the concept in corporate world which we will be discussing in this chapter. The whole idea and intent behind Shared service concept is to save cost.

Let’s take an example. Imagine a duplex bungalow where two families are living. They both have two separate kitchen with a cook working in each kitchen. Every kitchen has four major resources - Cook, Ingredients, Utensils and Fuel. Now if these two families combine their kitchen, they would get following benefits

• Single cook  with an assistant can work now to prepare food for both families
• Number of utensils required will be less 
• Ingredients required depends on quantity of food
• Fuel consumption would be reduced as entire food will be cooked at the same time

Because of all the above factors each family would now incur cost which would be lower than what they used to spend when their kitchens were separate.

This same concept is applied in corporate world. Let’s understand this with an example. Company A has three subsidiary, company B, C and D. Let’s consider an area of Accounts Payable (AP). Functions performed in AP is similar in every organization irrespective of nature of business of that organization. The primary role performed by AP team is to process invoices of vendors. Let’s say that the structure of AP team of all the above companies is as below:

Company	No of Team Leader	No of Team Member
A	1	6
B	1	4
C	1	3
D	1	3
Total	4	16

Now if the this organization want to set up a Shared Service unit for Accounts Payable team, one of the possible structure could be as below:

Company	No of Team Leader	No of Team Member
A	1	10
B
C
D
Total	1	10

As you can see from above two tables there were 4 team leaders and 16 team members before each company had their own AP team, but with shared service unit now the AP team has 1 team leader with team of 10 employees reporting to the leader. With this reduction in total headcount from 20 to 11 will definitely bring down the cost for entire organization.

Despite of the cost saving advantage there are some disadvantages also to this concept. Let’s revisit first example of two families with single kitchen. Earlier when the kitchens and cooks were different the food used to be prepared keeping in mind likes and dislikes of the each family, however now with the single kitchen and one cook the focus is more of preparing food for all the members of both family rather than likes and dislikes of anyone. Moreover since the food is prepared in large quantity there could be wastage if few members do eat it, which would lead to increase in cost.

Similar disadvantages will surface in corporate world also. In the above example of combined AP team, the focus of this new shared service unit would be entirely on just vendor payments because this is what they will be responsible for and their performance would be measured on this sole criteria. They won’t be concerned about cash flows and cash positions of individual companies. Since the AP team is working in isolation they won’t have visibility on the insights of the business of individual company hence at least one representative from each company will have to get involved with AP teams work which will unnecessarily increase the work load of that person.

One of the biggest issue in case of shared service is that of authority and responsibility. As explained earlier that the shared service unit does not have complete visibility of the business of individual company they would take inputs from a representative of individual company who would be responsible if anything goes wrong although that person does not have any authority. This representative does not have control over the team working in shared service unit. This representative would always be made a scapegoat.

Another concern is that of workload on shared service unit. As we can see in above example there are four companies having one common AP team. Now as the business of each of these individual companies grows the volume of work would also keep on growing which would increase workload on the AP team disrupting work life balance of employees working in this team. The way to reduce this workload balance is to increase the team size by recruiting more people in this team. However such support functions do not bring any revenue management would always refuse to bring in more people because this would lead to increase in cost without any increase in income. So management always prefers to put more burden on less employees rather than distributing this burden by increasing employee count.

The management thinker and inventor of The Vanguard Method, Professor John Seddon argues that shared service projects fail (and often end up costing more than they hoped to save) because they cause a disruption to the service flow by moving the work to a central location, creating waste in handoffs, rework and duplication, lengthening the time it takes to deliver a service and consequently creating failure demand (demand caused by a failure to do something or do something right for a customer)

Chapter 4: Resource Management System

An organization uses several resources to deliver its end product/service. Primarily all these resources can be categorized into following four category (Fig 4.1: Resources) - Employees, equipment, material and place from which business is carried out.

These resources will differ depending on business of the organization, for example if it’s a manufacturing company then the resources will be employees, machinery, plant, raw material, work in progress, etc. In case of a service provider resources will be employees, facility from where they provide service and equipment with which they provide service e.g. computer.

Proper management of all these resources from start to end is must for smooth functioning of business. There are several Enterprise Resource Management Systems available in market which provide one platform to manage all the resources of an organization. I am not going to do comparison of these systems in this chapter. We will be discussing whether an organization should implement a single system or different systems which are specifically designed for each function.

Answer is quite simple, there should be one single system for all the functions in the organization. Use of one single system removes chances of errors which could be there if multiple systems are implemented. Let’s take an example. In an IT organization employee is the most important resource as revenue generation depends on them only. So for this type of organization close monitoring of employee count, employee cost, revenue generated per employee becomes very necessary.

Now consider a scenario where there are two different systems, System A monitors employees details other than cost and System B which accounts for cost. These two systems are not connected to each other. Now if System B needs some inputs from System A then data will have to be extracted from system A and entered into system B manually. Whenever there is manual intervention chances of mistake is there. So if any mistake happens while entering data into system B then there will be difference between outputs of both systems. Then someone will have to reconcile these two outputs to do necessary rectification. And rectification is the most unproductive job as its just matching of two records, there is no useful output from it.

Nowadays it has become a trend in almost every organization to form a team, start a new project with some fancy name and output of such projects is usually some new system. This team working on a project will give a report stating that till now there was something wrong going on in the system and we can improve it by introducing a new system.

If there is any problem in the existing system then introducing a new system which will work in isolation is not the solution to the problem. Multiple systems working in isolation will only create multiple outputs which will lead to only confusion. Instead of introducing a new system it is always advisable to include additional features in the existing system so that it can serve the purpose.

An ERP should be developed in such a way that it will fulfill any and all requirements of the organization. From booking of a meeting room to procuring an assets, everything should be done through a single resource management system. 

Chapter 3: Life Stages (Part 3)

In part 1 and 2 we discussed about Introduction and Growth phase of business. Now let’s move on to next stage which is maturity. Now you are the giant, the big fish. At this stage the organization is big in every aspect, it is big in terms of number of employees, annual revenue, market share, global presence etc. Following are some of the things on which an organization at this stage needs keep tab on

• Market share
• Revenue and Margin
• Employees
• Competitors
• Global Presence
• Investors

Market Share

When an organization is at this stage it owns a large market share. At this stage it cannot grow its customer base any further as it has already got all the customers it can possibly get. Now the focus of the organization is to maintain this large customer base. The way to maintain customer base is to add new features to your product/ service. Continuously improve your product/ service through innovative ways. Most recent example for this is iPhone. Apple’s iPhone is now at maturity level. For this organization market is saturated now. So Apple is now trying to maintain its market share by adding new and more attractive features to its product. Recently they have introduced iPhone 7 which has more attractive features than the previous versions.

Revenue and Margin

At this stage although the numbers run into billion but the rate at which they grow is very less. Since the organization is operating at large scale it gets the benefit of volume. It is able to produce a product or provide service at a cost lower than its competitors who are at entry level. At this stage growing revenue and margin beyond certain level is not possible but the organization has to maintain it to continue its existence.

Employees

A mature organization has large employee base who come from different countries, different cultural back ground. All these people who have different thought process and different way of working come together to work for the organization. Management should create an environment in the organization so that all these employees can co-ordinate with each other and deliver results with least possible resistance.

Competitors

At maturity phase an organization has very few but very strong competitors who are continuously competing with each other for market share. One way of competing with opponents has been explained in the topic of “Market share” another way to maintain or increase your market share is to eliminate competitors is by acquiring them. This is also known as inorganic growth. Through acquisition an organization acquires customer base, knowledge, employee base etc. of its competitor.

Global Presence

As the business of an organization grows it has to set up its operations in different locations to get the benefit of different geographies. For example in hotel industry a property situated near beach can attract many tourists. A mining company has to set up its operations in the area where it can find the required ores. In order to set up operations in different locations an organization has to comply with the regulatory requirements of that region. This also plays a major role as it can have impact on cost of production. So before setting up facility at any location an organization must do an in depth analysis as to what benefits it is going to get by setting up facility at any location and at what cost.

Investors

An organization which is large in size cannot have single investors. Such companies are normally listed on a stock exchange and there are many investors such as individual investors, Mutual funds, Government, financial institutions. As mentioned in Part 2 of Chapter 3 – “New Investors” the founder must always keep the control with himself if he/she wants to run the business the way he/she wants.

Innovation is a balloon which helps business to keep floating, business would skid on the path decline if it’s not able to innovate, and I’d like to call it “The Floating Balloon Theory” (Fig 3.4). A mature organization must use innovative and creative ways to ensure its existence. It has to continuously analyze the changing needs of the customers and it has to provide not just what customer wants but something additional which will become need of the customer. An organization has to keep on analyzing the technological changes which could have impact on its business and adapt those changes to provide better product/ service to its customers, failure to do this would lead an organization to the decline stage which would result in demise of the organization.

“we didn’t do anything wrong, but somehow, we lost” – Steve Ballmer, Nokia CEO