Understanding Product Profitability

If you’re like the majority of retailer’s you have a pretty good idea of your business’s gross profits and the grow margin and/or markup of each of the products you offer for sale. Unfortunately, if you’re like most retailers you do not have an accurate understanding of the profitability of each product taking into account ALL expenses related to the operation of your retail store. How do you allocate rent, utilities, sales staff, back office personnel, advertising and promotion, capital expenditures and other overhead expenses? If you’re smoothing those expenses across all products by revenue generated, the accuracy of your product profitability picture is suspect.

A more detailed analysis of your product portfolio and the allocation of ALL business expenses to each product will provide valuable insights into resource allocation and product portfolio optimization. You may be selling products that are not as profitable as you think. You may be allocating floor space, inventory space and advertising dollars to the wrong product lines. Your overall store profitability is likely under-achieving as a result of a limited view of your true cost structure and an inaccurate methodology of cost allocation.

Now before your eyes roll back in your head and you start to dose off, remember this is about a more strategic approach to product management that delivers money directly to your pocketbook. This is not just a boring accounting exercise, but a laser like approach to identifying the winners and losers in your product selection. Some basic activity based cost accounting is required to be applied, but if you don’t have the skills yourself, seek out professional help. An objective outsider, with an understanding of retail principles and the ability to ask the right questions will rapidly be able to create a product profitability picture of your business. The application of cost pools, drivers, allocation methodology and volume variance analysis are some of the steps required to accurately assess product profitability to aide your strategic decision making.

In the end, a deeper, more robust understanding of product profitability will allow you to make the correct strategic decisions that enhance bottom line results, generating incremental profits you can take home or reinvest in the business. Embrace the numbers, don’t fear them. The ability for you to approach your retail business from a disciplined quantitative perspective will allow you to make better strategic choices, improve customer satisfaction and retention, increase competitive advantage and drive profitable growth.