It has always amazed me how many leaders of companies, big and small, overlook profitability of their products, stores, markets or channels. Of course, they know which items are selling, which stores have the most sales, what markets are driving the most customers into the stores and even which channels have the most volume. But do they really know where, or if, they are making money? Without driving customers into stores and attaining ever increasing product sales there would be no profit to even consider. But doesn’t it make sense that every business leader and employee should know and understand product level profitability? Without this level of insight, it is more than challenging for retailers to make the correct product, promotion, advertisement, shipping, inventory and production decisions! In a sense you are operating in the dark!
So how do you turn on the lights?
Step 1: Mapping Product Level Profitability
The first step is to map your primary business processes so you know how the work gets done. From sourcing your products, to thanking your customer as you hand them their newly purchased items. Does that sound overwhelming? Done at the right level of detail this work can be done quickly and effectively by starting with a list of your key processes. Next, identify the people with the most experience working in the process to help you identify the key activities and steps within each one. Using whatever mapping technique is comfortable, map out the flow of activities for each process. I prefer to use swim lanes which lists the various functions down the left and traces the activities, decisions, feedback loops and overall flow all in one visual.
Step 2: Time Evaluation
The second step is to determine how much time key resources spend “doing” activities in the process. You can collect this information by asking them to estimate. Remember to use the KISS principle, Keep It Super Simple, and ask them for a % of time spent in a week (ie, 10 hours = 25% of 40 hour week). In my experience, this method will get you 85% or greater accuracy which is more than enough for decision making.
After you have the time estimates, you can apply the full cost of the resources against the time by activity based on the percentage estimates. When you know the cost by activity and all other cost assigned to this process (ie, training cost for sales team in the example above) you can determine the fully loaded cost of your sales process.
Step 3: Cost
The third and final step is to identify which processes and costs are directly connected to the end objects, like products, you are trying to determine the profitability for. For example, when looking at product profitability you might connect the following process costs:
- Product Procurement
- Warehousing & Distribution
- Store Sales Team
Once you have the most direct cost assigned to the products you can calculate profitability as follows:
Product Sale Price
Less: Product Cost
Less: Assigned Product Cost
= Net profit by product
Repeat for store, region, market and/or channel levels. You will find that some activities and cost can most directly be associated at these levels (ie, advertising could most directly impact at the market or channel level) the same way you did for product.
Conclusion
In my experience when leaders have “true” product level profitability information the decisions they make are more likely to have the intended impact on company growth and sustainability. So, ask yourself, is my company is operating in the dark or with the lights on? Don’t become overwhelmed. Follow the KISS rule when executing these three steps. You’ll soon have the “true” profitability within your business!
