As companies constantly search for new ways to excel in increasingly competitive environments, new product offerings are consistently seen as key growth drivers. According to RSM’s 2017 Manufacturing Monitor, an annual survey of middle market manufacturing firms, 47% of respondents plan to grow through new products. However, middle market firms often do not have a detailed understanding of how their current or new products will impact their bottom line. Due to incomplete, summarized and bad data, companies are often limited to summary level analytics and the capability to drill down to a more meaningful level is constrained. By utilizing profitability analytics at a granular level, management is able to gather valuable data that improves both their ability to successfully introduce new products and improve the financial performance of existing offerings.
The most granular level of profitability is the individual product level. Achieving an accurate understanding of this requires a great deal of discipline, systems, and detailed data. It is essential to take a holistic view of the costs a product will incur. For example, products in the food and beverage industry may have strict sequencing and cleaning regulations to prevent contamination, or machinery may require a complicated set-up process. Is the time and effort required to meet those requirements reflected in the costing methodology? In many cases, costs like these are absorbed across the entire line of products, but it is important to evaluate if specific products require greater time and costs and allocate accordingly.
Strategic product pricing
Gaining product level visibility to profitability improves the ability to determine the effectiveness of strategic pricing initiatives. In some cases, it may make sense to undertake a loss-leader strategy, but it is difficult to truly measure without being able to isolate the effects of pricing decisions. An understanding of margins and costs at the individual product level should be used as one factor to make the best decision for the whole company. It provides the necessary information to define and quantify the costs of providing a specific item as well as the overflow benefits it may derive from promoting other products. Furthermore, contribution margins by product can provide visibility to pricing flexibility and be used to improve overall financial performance.
Channel and region profitability
Companies often approach sales channels and regions as if one-size-fits-all. Logic suggests that products should be dispersed as widely as possible to facilitate growth. However, it is necessary to utilize analysis to determine the following before making a decision:
- Who are our competitors?
- Can we effectively compete in a channel or region?
- Is a different type of packaging or marketing required?
- Are the required resources more effectively employed elsewhere?
- Can we effectively ship into the region?
- Are prices reflective of the region’s appetite?
- Will this addition adversely affect the remainder of our business?
Determining and changing pricing for individual customers can be extremely tricky. Changes are often avoided because of the time it takes to build a relationship, discounts are baked in overtime, and special exceptions may be given to customers that promise outsized growth opportunities. Margin analysis cannot replace the relationship building and negotiation process, but it can be used to guide it to a more beneficial outcome. By defining profitability at the customer level, management is better informed of where to devote resources and which relationships need to be redefined. Often we “think” we know our most profitable customer, but the volume of purchase or unit price can be misleading, as we aren’t seeing the total relationship.
By utilizing profitability analysis, companies are better able to improve the performance of existing products and maximize the impact of new products on the bottom line. The search for the next competitive advantage may be best guided by looking inward first – through better information and analysis from existing operations.