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Using
Profitability
Analysis to
Strengthen
Customer
Relationships
Product/Service Profitability & Product Strategy
It is surprising how often product and service strategy is developed without explicit consideration of product/service profitability. While strategy to improve profitability of course requires such consideration, many product/service extensions and development programs are created under the assumption that profitability is a given or an assumption. In most cases, no product/service strategy should be developed without a profitability analysis foundation. Why?
Most businesses today have no accurate picture of profitability by product and service. What they think is profitability is really just an accounting version that typically excludes huge chunks of cost. In manufacturing, product cost is manufacturing cost generated by the cost accounting system. It nearly always excludes distribution costs, selling costs directly incurred by the product, and even services costs like customer support, warranty and returns processing. In banking, the picture is similar — costs are limited to direct costs such as interest paid and external processing unit costs. Very few banks dig deeply enough to get a complete picture of costs generated by each major product and service they offer.
When you do a proper profitability analysis, what you typically find is that up to 80% of your profits are being generated by about 20% of your products and services. The bottom 20% are often heavy loss producers and are being subsidized by the profitable products. Some of the big losers are likely to be among your highest volume products and services.
With this knowledge available, you will probably want to look very differently at product and service strategy. You are likely to seek ways to stop the bleeding from high volume loss items. You will surely want to increase volume among your top profit producers. And you may want to think about trimming some of your low or no profit items. This nearly always leads to a very different strategy mix than if you proceeded without vital profitability knowledge.
Our Services
We can help you develop true costing for your products and services. This starts with accounting costs generated by your existing financial systems but adds costs for each step in the end-to-end, sales-through-delivery process. There are quite a number of tricks to doing this that you learn after completing a number of these analyses. One such "trick" is making sure that you end up with a set of costs for each product and service that, when multiplied by unit volume, add up to your total costs for functions included in the cost build-up. This ensures that any errors are limited to allocation among products and are not the result of cost double-counting or rough estimates that are way off.
Much of this work can be done using database extracts dumped onto CDs as source data, eliminating the need for programming other than simple queries. Only after you have completed an initial offline profitability analysis should you consider adding programs to compute it routinely or purchasing a packaged activity-based costing application. You need the findings from the initial analysis to properly specify your permanent system.
If you have questions or would like to discuss how we might be able to provide a full-costing process for your organization, please contact us.