Thursday, November 20, 2014

Category Management & Direct Profit by Products: When product complexity hurts true profitability

I wanted to share with you an interesting document I found wrote by Accenture. It is directly linked to my previous post about the Direct Profit by Product Analysis. This document is Named "When Product Complexity Hurts True Profitability". 

This concept is very true especially in category management in the FMCG world. As the article points out, the number of Skus in product range is constantly growing. It is actually growing faster than the sales do, which means the sales/product figures are declining fast. That means categories are losing efficiency.

Moreover, the more product you retail the more costs will be implied in your activities. That means more room in your warehouse, more data to analyze and to deal with for accountability and management, more time spent to set up products on shelves. More products mean more sales, but don't mean more profits in the end for sure.

The article emphasizes that there is a need to understand hence this complexity and its impact on the cost of goods sold, and therefore the profitability. Hence you need to track all the costs linked to one product. As the article says:
 These include direct labor and materials costs, administrative and sales expenses, rebates, discounts,
supplier overpayments, an allocated portion of the company’s cost of capital, and whatever other charges and expenditures the company makes related to the product.

Accenture analysis reveals that most blue-chip companies have about 65 percent of their revenues tied up in their cost of goods sold (COGS). Of that, more than 80 percent is for direct material costs. Clearly, if firms hope to improve a product’s profitability, COGS is where to start.

Winners and losers
In the example below, Product A is a typical underperforming product, with high direct costs. Even though the indirect costs are fairly low, Product A would typically be eliminated as both the true margin contribution and the sales volume are low. However, if the product is strategically
important—such as a legacy product—or has development potential, that has to be
taken into consideration.
Product B is a typical high performer. Direct costs are low, and even though indirect
costs are fairly high, the true profit margin is still high. The product’s sales volume
is above average but not as high as you would want with a high true profit product.
This means that Product B is a good candidate for a more focused sales effort.
Product N is a typical representative for true profitability improvement potential;
generally this type of product accounts for a large portion of a company’s product
portfolio. The true profit margin is rather low, but sales volume is high. The product
could benefit from product reengineering and design-for-assembly to minimize
the direct materials and labor costs.

These kind of analysis are I believe very interesting in terms of category management. What is also very interesting with this analysis is that it may evolves not only depending on the negociation of the gross sales price, but could evolve depending on the work ones may do on some part of the costs of good sold.

I believe that these approach will tend to become the norm, sooner or later.