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Managing Product Profitability

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Tracking and assessing the profitability of your products are important for managing products and services. Informal surveys of participants in our product management and marketing classes reveal, however, that a majority of product managers do not have access to that information.

Most product managers said they do not have detailed knowledge of the financial performance of their products, or are not even held accountable for product profitability. Furthermore, they indicated a lack of available financial information regarding customer profitability. And most indicated that they do not have any formal education in financial management.

How then, is it possible to

  1. Figure out whether your product is achieving marketplace success

  2. Find out where your product is situated along the product lifecycle curve

In many cases, financial representation on the cross-functional product team may be limited or absent, hence the information and insight needed to assess product line financial performance is less robust than needed.

This article is designed for the product manager or product marketing manager who needs to ensure that the product's planned and actual financial performance are aligned with the goals of the firm.


First, let's take a look at how financial information is used in managing products and services. By understanding the financial methods and tools, you will be able you to plan for, and deliver, optimal financial performance for your products:

  • Building business cases. Business cases are used to justify investments in new products or product projects. They represent the baseline for product financial planning. They also enable the testing of outcomes using alternate assumption sets (sensitivity or what-if analysis) expressed in financial terms.

  • Prioritizing investments in new products or projects. Each new product proposal or new product project (line extensions and derivatives included) has a financial or investment profile because each investment proposal draws on corporate resources and, therefore, should project a positive financial return for the firm. When alternate projects are proposed, the financial measures may be used to prioritize the list of projects based on projected financial returns.

  • Budgeting and planning. During the corporate budgeting and planning process, product groups should be laying the financial groundwork for their “businesses.” Each product should be considered a “business in a business” and should, therefore, be creating a profile for unit forecasts, cost of goods sold, expenses and profit. As the financial period progresses, it is imperative to be able to assess actual performance so that the product manager can compare the actual results to the budgeted or planned performance. When variances are understood and analyzed, the outcomes are revealing.

  • Analyzing product performance. As your product moves through the various phases of the lifecycle, product and marketing managers should be tracking the performance of the product against planned targets. If you have established metrics like sales, market share, cash flow, etc., you're able to track (and graph) the actual performance against your product plans. The way you adjust the marketing mix is dependent on the guidelines you should have established in your product and marketing plans. The faster you recognize the signals from the market, the faster you can respond and adjust the levers of the marketing mix.

That was the context. What follows, below, are the tools and techniques used.

Financial Statements

  • Profit and Loss (P&L), also called an income statement, is used to plan for and assess business performance over a given time period—such as a month, a quarter, or a fiscal year.

Take a look at the structure and formulas within this P&L sample:

SALES PLAN The Math
Number of Units 1,000  
Price/Unit $5.00  
Total Sales $5,000 # Units x Price
     
COST OF GOODS SOLD (COGS)    
Number of Units Sold 1,000  
Cost per Unit $2.00  
Total Costs of Goods Sold $2,000 Units x cost/unit
     
Gross Margin $3,000 Total sales minus COGS
GM % 60% COGS $ / Total Sales
     
DIRECT EXPENSES    
Marketing 350  
R&D 500  
Sales 750  
Depreciation 50  
Total Expenses $1,650  
     
Earnings Before Interest and Taxes $1,350 GM. Direct Exps $1,350 GM. Direct Exps
Interest Expense $35  
Earnings Before Taxes $1,315  
Income Taxes $250  
Net Income (Profit) $1,065  
  • Cash flow is an important measure that serves to show how funds are flowing into and out of the firm. Product managers should be concerned with cash flow in product planning activities so that they can forecast when cash will begin flowing into the company from product sales.

  • Balance sheet is a financial statement that takes a snapshot of the assets and liabilities of the firm at a specific point in time and depicts the overall net worth, or value, of the firm at that point in time. The reason a product manager might be interested in a balance sheet is that the product may require production capacity to make or build the product. Buildings, machinery and equipment are purchased from corporate funds, and the values of those assets are shown as assets to the firm. Over time, the equipment or facilities may be depreciated, according to established accounting rules. That depreciation may appear on the P&L as an “expense.”

Now that you're aware of the major financial statements, what are the main methods that can be used to analyze the performance of the product's business?

Variance Analysis

One of the most important methods is variance analysis. Variance analysis takes a financial plan or budget and compares that plan to the “actuals” incurred. We'll take the sample P&L above and show you this information in the space below:

  Plan Actual Variance
SALES      
Number of Units 1,000 1,250 +250
Price/Unit $5.00 $5.25 +.25
Total Sales $5,000 $6,875 +$1,875
       
COST OF GOODS SOLD (COGS)      
Number of Units Sold 1,000 1,250 +250
Cost per unit $2.00 $2.30 (.30)
Total Costs of Goods Sold $2,000 $2,875 $(2,875)
       
Gross Margin $3,000 $4,000 +$1,000
GM % 60% 58.2% (1.8%)
DIRECT EXPENSES      
Marketing 350 450 $(100)
R&D 500 525 $(25)
Sales 750 680 +$70
Depreciation 50 50 0
Total Expenses $1,650 $1,705 $(55)
       
Earnings Before Interest and Taxes $1,350 $2,295 +$945
Interest Expense $35 $35 0
Earnings Before Taxes $1,315 $2,230 +$915
Income Taxes $250 $345 $(95)
Net Income (Profit) $1,065 $1,885 +$820

If you were to review this financial statement, you might come up with a series of questions. For example, why were sales higher than planned? Was it because of an increase in marketing expenditures? Why were those marketing expenditures higher than plan?

How would you find out the answers to those questions and more?

And what would you do with the answers?

You can use a table or format like this to organize your questions and structure your action plans:

Question to ask about the variance Where you might find an answer to this question. Whom would you ask? How would you take the information you learned and apply it toward making changes to the business?
     
     
     

By using this approach, you can raise questions and issues that should be addressed cross-functionally. Resolving these issues can ultimately improve the market performance and profitability of your products and services.

Financial Ratios

To better assess the financial health of your product, you can use financial ratios. They are divided up in broad categories. These are two of the categories:

  • Profitability ratios demonstrate how well the business is performing.

  • Growth ratios show how the company or product is growing in market share.

You can look in a financial management textbook for more detailed ratios and their applications. Industry ratios are also available from a variety of sources, such as brokerage firms, Dun & Bradstreet, and industry research organizations.

Ratios alone say little. Ratios are used within the context of industry or business averages, thereby providing a relative standing of your business against others in similar business categories. They also can be used to show relative trends in movement of your business over time.

A simple example is product profitability. If your profitability is growing over a period of quarters and then begins to deteriorate over time, you know that your business is facing some challenges. However, if you observe that there is a general economic downturn and note that other companies in your industry are also experiencing the same profit pressures, the actions you take may be different.

One final note on ratios: as you manage your products as they move through their lifecycles, you'll note that the indicators on which the performance of your product is based require fine-tuning. The performance levers you'll adjust correspond to the marketing mix. The marketing can be adjusted upward or downward, depending on your business goals. The financial statements, particularly the P&L, and the ratios used to analyze the business are the vehicles that convey the information to the product team as to the overall outcome of those marketing mix adjustments, so that further adjustments can be made as the product evolves across the lifecycle.

You don't need to be a financial expert to have a comprehensive understanding of the financial dimensions of your products or services. Each product manager, as a “mini-business” owner, or acting as the general manager for that business, should have some degree of financial acumen. Some understanding of the numbers, and the data behind them, is imperative to ensure that the performance of your products and services is optimized for the firm.


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Steven Haines is the founder and president of Sequent Learning Networks (www.sequentlearning.com), a firm providing product management and marketing training and consulting. Reach him at sjhaines@sequentlearning.com.

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