Multiple Products: Are Your Winners Subsidizing Your Losers?
Making The Case For Financial Analysis And Cost Accounting
Know Where Your Profits Are Coming From
If your company delivers multi products or services, do you know which ones are contributing to profits and which ones are actually dragging down your potential profitability. Most business owners fail to maximize short- and long-term profitability because they fail to routinely conduct this type of analysis. The greater the number of products or services you provide, the more crucial this type of cost contribution analysis is.
Let’s examine several scenarios (I’ll use the term “product” to include both products and services):
Number 1: The product which generates the highest percentage of revenues costs you the most (direct cost) to produce, and actually renders the lowest profit margin or contribution to fixed cost coverage;
Number 2: The product which generates the highest percentage of revenues costs you more to produce than you charge per unit, so it is a drain on the profitability of your other products, which may be less glamorous, but which generate healthy profit margins;
Number 3: Several products which are small contributors to revenue happen to generate the highest profit margins and are actually subsidizing your company’s greatest revenue-producer, which has a minimal or negative profit margin.
You can make the above determination with the help of some cost accounting and financial analysis – if your accounting staff cannot do this, hire an independent professional consultant to do this work and prepare a report. Then act on that report!
Once you have obtained that report (and the information unearthed is often very surprising) you should take the following steps, although you must occasionally allow a marginal “loser product” to continue in production and sales simply because it is important to your reputation or branding, or because it actually contributes in some way to the sales of the more profitable of your multiple lines. The classic example is the program where you give the razors away at a loss and make all of your profits on the special razor blades or cartridges – specially designed to fit your ‘unique’ razor design:
Step 1: If the market is sufficiently large for a profitable product, consider investing more deeply in marketing that particular product;
Step 2: If a product is inherently unprofitable (and to the extent that it does not stimulate sales of your other multiple products), either stop producing and selling it, or, if the market is large and your competitors are all marginal, consider 1) raising your price per unit, or 2) reducing the cost of production per unit. In some cases, a larger run of production can generate significant economies of scale and increase profit margins for the product on the whole. If neither of these two alternatives are possible, work toweard eliminating that product from your portfolio of offerings.
In viewing your company’s performance, it is not adequate to simply know how much revenue and profit are being generated for a given accounting period – it is every bit as important to know where your profits are coming from (i.e., from which products), and where they are being lost.
Ultimately, by acting on this extremely valuable information, you can optimize your product mix and maximize your profitability potential.
Douglas E. Castle
NOTE: THE INFORMATION CONTAINED IN THIS ARTICLE SHOULD NOT BE CONSTRUED BY THE READER AS BEING LEGAL, FINANCIAL, TAX, ACCOUNTING, ECONOMIC OR INVESTMENT ADVICE. NO OFFERING OF SECURITIES OR OTHER INVESTMENT INTERESTS OF ANY TYPE IN ANY ENTITY IS MADE HEREBY, NOR IS A SOLICITATION FOR THE PURCHASE OF SECURITIES OR OTHER INVESTMENT INTERESTS OF ANY TYPE IN ANY ENTITY MADE HEREBY. THIS ARTICLE IS INTENDED FOR GENERAL INFORMATIONAL PURPOSES ONLY AND REPRESENTS THE VIEW OF THE AUTHOR ONLY.
THIS ARTICLE IS COPYRIGHT 2014 BY DOUGLAS E. CASTLE, WITH ALL RIGHTS RESERVED. ANY REPRODUCTION, TRANSMITTAL OR DISTRIBUTION OF THIS ARTICLE, EITHER IN WHOLE OR PART, IS UNAUTHORIZED AND MAY BE UNLAWFUL, UNLESS FULL ATTRIBUTION IS GIVEN TO THE AUTHOR AND ALL IMAGES AND LINKS IN THE ARTICLE REMAIN INCLUDED AND “LIVE.”
The Douglas E. Castle Consultancy offers a complete suite of business consulting and advisory services for organizations ranging from seedling, "bootstrapped" startups, through established small- to medium-sized enterprises conducting commerce both domestically and internationally.
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