Concept:
Businesses that do not measure true profitability of products and product groups risk diluting profit margins when the sales mix changes from high to lower margin products.
Sales teams need to receive timely and accurate information to assist in developing pricing strategies and need to be targeted against contribution or profit generation in addition to the standard volume/revenue targeting.
Example:
In this example, products A, B and C are each costed using an average labour cost allocation (total labour cost divided by total volume produced), which indicates that each product is generating the same unit profitability of 10.
Product A | Product B | Product C | |
|---|---|---|---|
Cost of Materials | 50 | 60 | 70 |
Cost of Labour | 20 (15) | 20 (30) | 20 (35) |
All Other Costs | 40 | 40 | 40 |
Sales | 120 | 130 | 140 |
Profit | 10 | 10 | 10 |
(True Profit) | 15 | 0 | (-5) |
After re-costing based on allocating the labour costs more accurately (e.g. small runs = lower productivity), with the revised costs in brackets, the product profitability position is very different. In this case, based on the real example of an FMCG company, this only became apparent when profits fell sharply, following a major change to the company’s customer and product mix. Action was then taken to increase prices and/or reduce materials/operating costs for Products B & C.
Ask yourself:
- Do you measure product/product group profitability?
- What effects product profitability for your business? e.g. run length, product complexity, machine changes, number of processes, stock levels, distribution costs, etc.
- What plans can you put in place to improve profitability?
