Customer and Product Profitability:
In order to fully understand the profitability of a business unit, brand or product line, a detailed profitability analysis is performed. Most companies have systems that report gross margin by customer or product, however, our experience has shown that looking at gross profit is usually misleading. Many companies assign a standard cost to production, which is an average cost per unit, when the true cost per unit of production can vary widely depending on what is produced. For example, a large package size is generally more economical to produce than a small package size. Assigning a standard cost per unit of product can seriously skew the reported gross profit. In addition, gross profit does not reflect the true cash contribution generated by a product line or customer. Our analysis corrects this.
The costs that follow gross profit, especially distribution, sales and marketing, have a significant impact on the profitability of a customer. An example is a customer who always orders well in advance and picks up at the dock compared to a customer who makes changes to his order right up until shipment and must be delivered to his store and put onto the shelves. The latter may have a higher gross margin, but a much lower profitability.
Many customers receive discounts and allowances that are paid as rebates rather than deducted from the invoice. Most financial accounting systems do not account for these in customer or product gross profit, thereby inflating the reported customer and product profitability.
When we perform customer and product profitability analyses, we work with the production organization to understand the true cost of production of different products and package sizes. We work with marketing and sales, including the customer service operation if necessary, to understand the time required to deal with different customers and to itemize all of the discounts, allowances and rebates that each major customer receives.
It should be noted that when looking at customer profitability, the analysis often requires that all of the business units be examined. Many customers purchase products from all of the business units, and whereas the profit from a customer in one business unit may be small, the same customer may be the most profitable customer in another business unit.