On Management

Whenever a company's profitability starts to go south, senior executives immediately embark on cost-cutting campaigns. That's understandable, but is cost the real issue? A few of the smarter ones will look at pricing to determine if they are charging what the market will bear. But only the most astute examine the mix of their products and customers. This is where the critical issues often show up. When I use the term "mix," I mean the combination of unit volume, product or service being sold, and associated profit margins -- or the assortment of customers to whom they are being sold. A relatively minor shift in mix from the most-profitable products to the least-profitable ones can have a devastating effect on the bottom line, far greater than pricing or cost changes. Similarly, tying up valuable capacity to supply low-margin customers or those that actually cause you to lose money also can spell disaster. Everyone focuses on costs. Everyone also focuses on prices. That's fine, but the mix is the critical third piece. And this frequently is where the greatest opportunity for improving profitability lies. The key to monitoring the mix is to organize the relevant information, both before decisions are made and as they are made. The upfront examination involves a simple format that most companies already have, but seldom use. I call it a "mix-and-margin" report. For each product the format includes: unit and dollar sales volume, pricing (actual or expected, not some imaginary list price), costs (actual costs, not inflated "standard" costs), and margins (percentage and dollars). The data must be collected for each item, subtotaled by category, and finally totaled for the entire product line. All of this information is readily available in most companies. Now construct pie charts and study the percentage of sales and profits contributed by each product, category, or product line -- as a percentage of the respective totals. Next, create a table (or matrix) from this information. This matrix paints the mix-and-margin picture for product sales and profitability. Study which products and categories make up what percentage of your total volume. You may be surprised. Do the same thing for customers -- one at a time and then in the aggregate. This matrix should reflect the models that each customer purchases, along with volumes, prices, costs, and profit margins for each customer. Don't forget to factor in all those special deals, "freebies," trade allowances, and freight costs, etc., that affect your real margins but aren't necessarily captured in the direct pricing/costing. Now create a table showing each customer's projected sales volume and contribution to profitability (both percent and dollars). The totals from the customers' mix-and-margin reports give you an economic picture of your customer mix. Determine what percentage of the totals each customer represents. Check how your volume and profits are spread across your customer base. More surprises? A wealth of decisions and actions can spring from such analyses. These include reshaping (by pricing, promotion, or distribution) the mix of products to improve margins; making better use of your capacity; and improving your competitive position vis--vis a particular competitor. Shifting the shape of the customer base takes more time, but can yield powerful strategic advantages -- and improved profits. These mix-and-margin reports must be used when planning the year in advance and tracked every month -- or more often if that is possible. Ideally, they should be available on demand, but the monthly accounting cutoffs in many companies may dictate that what you'll get are monthly reports. Compare mix and margins to the budget and prior year (best done in one report), as well as for the current month and year-to-date (best done in two separate reports). Understanding the powerful mathematical and financial impact of shifts in your mix is critical. Tracking them is equally important, but taking decisive action to drive mix and margin in the right direction is the key to success. The tools that make this possible are widely available. But will managers use them? I hope so. It can make a big difference in the bottom line. John Mariotti, a former manufacturing CEO, is president of The Enterprise Group, a consulting business. He lives in Knoxville. His e-mail address is [email protected].