As the financial landscape becomes increasingly complex and competitive, Chief Financial Officers (CFOs) are charged with the crucial responsibility of maximizing profitability for their organizations. Amid shifting market dynamics, one intensifying challenge that CFOs must tackle head-on is margin erosion. Understanding what margin erosion is, its causes, and how to prevent it are essential for CFOs seeking to safeguard their company’s bottom line and ensure financial success today and tomorrow.
In this article, we’ll unpack the concept of margin erosion and dive into the root causes, examining both internal and external factors. We’ll explore strategies and best practices that finance leaders should adopt to prevent margin erosion, protect their company’s profitability, and enable growth.
What is margin erosion and how do you calculate margin erosion?
Margin erosion is a term frequently tossed around in the business world, but it’s essential for CFOs to fully understand its implications. What is considered a good or healthy margin varies depending on industry, product, and business goals. Ideally, an organization’s margins should be comparable, or higher than, similar businesses in the industry. However, a consistency reaching across most industries right now is margin erosion. Simply put, margin erosion refers to the gradual decline in profitability of a company over time, meaning that the percentage calculated below is getting smaller and smaller.
Margin = (Revenue – Costs of Goods Sold) / Revenue
Margin erosion occurs when costs increase faster than prices, cutting into the revenue generated by sales. This results in a shrinking gap between the cost of production and the revenue generated, ultimately leading to lower profit margins. It’s a significant concern for businesses as it directly affects their bottom line and long-term sustainability.
Common causes of margin erosion and impacts to your business
Given today’s macroeconomic uncertainty, including geopolitical and economic instability, tightening financial conditions, higher costs, increased disruptions and inflation, the economic restructuring largely contributes to margin erosion. Operational frameworks that have been the status quo can no longer keep up with profitability and growth concerns, or handle today’s pace of change.
According to Coupa’s 2024 Strategic CFO report, 90% of CFOs are concerned their organizations won’t hit its revenue forecasts.
Organizations experience declining margins from internal factors as well, including outdated IT approaches and systems they have in place. Disconnected and complex processes lead to higher operating costs, expenses, and errors. For instance, manual invoice and PO processes, long invoice and expense report approval cycle times, manual payments, and more all impact a company’s profitability. Ineffective cost control measures and a lack of streamlined processes are what stand between where you are and where you need to be. And each of these factors chip away at the organization’s margins. This puts companies into what we call the margin erosion zone.
It’s the gap between how companies need to perform, and how they’re actually performing to keep up with complexity that erodes margins. Many organizations can’t see where that gap is either because of how they operate, and with each day that goes by without addressing the margin erosion zone, it gets wider and wider.
This has a domino effect. Organizations enduring higher costs and external volatility have limited access to operating capital that they’ve relied on to fund growth in the past. This puts pressures on third-party relationships and costs, forcing CFOs to find other ways to fund growth.
As a result, the organization moves slower, has delayed responses to disruption, and becomes less competitive. This gap makes it more difficult for CFOs to now answer crucial questions, such as “where can the organization free up money without reducing headcount?”
As it becomes clear that short-term measures don’t prevent margin erosion, total spend management is emerging as a reliable, sustainable, and comprehensive approach to ensuring profitable growth. Sales forecasts remain unpredictable, so CFOs and finance leaders are paying closer attention to what they can control – technology and processes that can protect margins and enable growth in the face of unpredictable external factors.
Leveraging AI technology to protect and improve margins
To prevent margin erosion and solve this gap, organizations need a margin multiplier. The multiplier effect happens when small changes cumulatively lead to a disproportionate impact. Therefore, a margin multiplier happens in several areas of an organization when improvements to their operating model cumulatively compound to deliver outsized positive impact to their margin.
Margin multipliers help achieve margin expansion by cutting through complexity to improve operations in five key areas:
- Efficiency: By finding the right suppliers, making smarter sourcing decisions, and optimizing employee purchases, finance leaders create an efficiency multiplier that can save millions, even billions, of dollars.
- Productivity: With an easy-to-use and intuitive user experience, finance teams can quickly get the job done so they can focus on more strategic work. For example, faster approval cycles save finance time and money. This is a productivity multiplier.
- Sustainability: Achieving ESG/DEI goals and reducing carbon footprint by identifying the right suppliers enables organizations to optimize their supply chain, thus creating a sustainability multiplier.
- Resiliency: When disruption hits, from factory shut downs to bank failures, organizations need an advanced platform that identifies and executes actionable alternatives to minimize the impact to operations. A resiliency multiplier mitigates business continuity risk.
- Growth: Growth comes from increasing your cash flow. For organizations in industries that have thin margins or low to no growth environments, earnings growth comes from cost and margin control. The cumulative effect of all of these multipliers results in a growth multiplier.
The cumulative impact of these multipliers can, for example, result in moving selling general and administrative (SG&A) expenses or operating costs to research and development (R&D) or revenue generating lines like sales or marketing.
So how do you create a margin multiplier in today’s volatile business environment? Advancements in artificial intelligence (AI) make a margin multiplier possible. It provides the ability to handle huge volumes of data, reduce human error, and automate routine tasks. This enables finance leaders to confidently drive better outcomes and decisions in a world of increased complexity, tighter constraints, uncertainty, and volatility.
However, not all AI is the same. The right data are crucial because any AI solution designed to support smarter decisions is only as good as the data it’s built on. Data scraped off the internet (or based on surveys), collected for a few months or from a limited number of customers, and run through public LLMs will train AI-driven solutions that reflect these limitations, and, ultimately, do little to move businesses out of the margin erosion.
This is why it’s critical to understand the data organizations use. You must understand if the data is in the public domain or proprietary, where it comes from, how much they have, and if it’s secure and confidential. After all, the best AI only comes from the best data (more on that below).
How Coupa, the Margin Multiplier Company, helps organizations increase profitability and growth
It’s the right data – data that have been safely and ethically sourced for years, from thousands of customers and millions of suppliers, kept safe and secure, and only used with private large language models (LLMs) – that helps companies expand their margins and drive profitable growth.
Gaining a margin multiplier is possible when leveraging the compounding power of Coupa’s community-generated AI, AI trained on data from more than $6 trillion of real-time global transactional spend across a network of roughly 10 million buyers and suppliers for more than 15 years. With data from companies of all sizes, in every industry, and across the world, Coupa and its customers have embraced AI before it was AI. From purchases and approvals, to invoices, contracts, and everything in between, the Coupa community created a competitive data advantage that’s the bedrock of Coupa’s platform.
Community-generated AI drives real margin impact– the predictive insights, prescriptive decisions, and automated actions capabilities that we’ve been innovating and building with our customers for more than a decade. The outputs of Coupa’s AI models are based on best practices and are clear, actionable, and trusted. This AI underpins Coupa’s Total Spend Management platform that has a breadth and depth of capabilities to help you achieve your optimal operating model and drive margin growth in the five key areas mentioned above: efficiency, productivity, resiliency, sustainability, and growth.
The economic restructuring and compounding complexity further escalates the need for Coupa’s advanced platform to keep pace with the explosion of data demand and supply chain signals. The platform not only identifies cost saving and efficiency optimization opportunities, but also anticipates and avoids disruptions. Additionally, Coupa helps organizations realize savings with a network of more than 10 million vetted suppliers, fast supplier onboarding, pre-negotiated contracts, and out-of-the-box catalogs. Coupa’s advanced AI-driven platform is the biggest defense against margin erosion.
Leading companies have achieved similar objectives by utilizing the power of Coupa’s platform to create margin multipliers:
- Novo Nordisk – The Denmark-based pharmaceutical company behind Ozempic reinvests its savings into research. Before Coupa, it was difficult for researchers to purchase lab equipment leading to poor user adoption and spend leakage. Additionally, they had multiple fragmented solutions which resulted in siloed data and a lack of visibility. With Coupa, Novo Nordisk saved €45M from a complete digital transformation. Coupa is a growth multiplier for Novo Nordisk because the company now uses its procurement savings to fund research and development (R&D) that fuels its growth.
- AstraZeneca – The company struggled with a legacy purchasing system that resulted in low user adoption for global scientists and poor spending capture. Requisition approvals and invoice processing costs were high due to troubleshooting and manual data entry. With Coupa, AstraZeneca gained a productivity multiplier by reducing invoice approval times from 60 days to 4.5 days – a 93% boost in productivity.
- Procter & Gamble – Before Coupa, slow procurement processes hampered product launches, while difficult-to-use legacy systems required costly maintenance. Coupa became an efficiency multiplier for Procter & Gamble, helping the organization to quickly match invoices and purchase orders, reducing cycle time from days to hours and creating $1 billion in total savings.
- Microsoft – Microsoft is on a journey to become carbon-negative, water positive, and zero waste by 2030. Coupa is a sustainability multiplier for Microsoft because it enables Microsoft to create and sustain the most efficient, innovative, and sustainable global cloud logistics network. Microsoft does this by making intelligent data-driven decisions based on costs, carbon emissions, and cycle times. With Coupa, Microsoft found hundreds of millions of dollars in cost reduction opportunities and reduced emissions from their hardware supply chain by 60%.
- American Red Cross – American Red Cross struggled with a lack of visibility and control over spend caused by inefficient manual processes. The nonprofit organization also experienced a challenge of meeting diversity and inclusion (D&I) targets. With Coupa, American Red Cross gained a sustainability multiplier by achieving a 35% increase in spend with diverse suppliers. The nonprofit also achieved $4M in working capital improvements and $15M in cost reduction.
As the Coupa community continues to grow, the collective data compounds, and everyone becomes smarter and more strategic together. This is how margins multiply.
