Four Steps for Assessing Product Profitability
When you close the books each month, are you getting a true analysis of the profitability of your
products? If not, your most crucial business decisions may be misguided. Using the following four steps to assess product profitability for each of your products or product groups will ensure that your financials and KPI dashboards are aligned. And with monthly assessments, you’ll always have a clear idea of which products are performing as well as a preview of future trends.
Strong documentation of product profitability begins with separating products into categories like “economy,” “core,” and “growth.” With input from the sales, marketing, and operations teams, build a strategy that includes margin targets that each category of products must hit to remain viable. Based on monthly documentation, place products on probation if they fall outside the target range. Develop an action plan to improve the profitability of underperformers or plan to phase them out over a specified time frame.
This strategy of clear documentation, measurable targets, and timely reviews can help you avoid keeping a product in your lineup longer than is warranted based on profitability. It also identifies downward trends quickly and aggressively addresses them in partnership with sales, marketing, and operations, possibly reclaiming profitability.
Take a look at external factors and develop strategies to address opportunities and concerns that are impacting the profitability of your products. Generally, external factors should include competition for each product; anticipated market changes; inelasticity or elasticity of demand; and, when appropriate, opportunities for product improvements and spinoffs. Again, the analysis and action items should be developed in collaboration with sales, marketing, and operations partners.
As you develop an understanding of relevant external factors, assess the impact each factor has on your products. Most external factors have the potential to impact all teams — sales, marketing, and operations. Some very discrete factors, such as available shelf space at certain customers, may primarily concern only a single team, but they should regularly be included for consideration by all. While assessing margins for current products, keep an eye on longterm planning goals at the macro level that may influence future profitability. For instance, say your company is planning a new manufacturing facility, and you become aware that excessive supply chain costs are a drain on product profitability. Your awareness may equip you to lobby for choosing a more favorable location that reduces shipping costs.
As you focus on product profitability, don’t underestimate the importance of well-designed data reporting. Use an “item master” to organize data and sort it through the categories you selected during documentation. Such disciplined analysis helps you avoid an overly cumbersome reporting process and risks of inconsistency.
Once you have well-designed reports, subcategories can be added to allow for more granular analysis, such as comparing factors including geographic, demographics, and external forces. Correctly designed reporting also makes it easier to share information, compare across time and match the data to previous decisions.
Once you have a strong framework for analyzing product profitability, distributing the information to the right people in your organization is paramount. Determining the factors that impact your products and sharing that information with team members in sales, marketing, and operations helps each discipline contribute to maintaining and improving profitability.
While the frequency of communication about profitability may be monthly, quarterly, or twice a year, contingency plans should be automatically triggered any time the finance team notes a major product decline or troubling trend. You may also find that some profitability challenges, once identified, require ongoing attention and a constant action plan in order to preserve acceptable product margins.
An example of the need for ongoing profitability oversight is offered by a product, such as one containing high fructose corn syrup, that is no longer selling well. Using external analysis, you determine that your competition is likely suffering as well. The ability to adapt with better, healthier ingredients and offer an alternative to consumers can separate your product(s) from those of competitors. The change will require a strategy that engages the product development team, marketing, sales, and production over a period of time. While the example is a simple one, using a disciplined approach to assessing product profitability beyond margin expectations can give the team an early warning signal that a product or product line is at risk.
When it comes to assessing the profitability of products, the four steps of documentation, external analysis, design, and distribution can help ensure a consistent and credible outcome. Collaboration, coupled with a commitment to a disciplined process, can lead to better product decisions that impact business operations, valuations, and long term strategic planning.
Contributing author and Riveron Senior Manager, Matt Freeman.