When you sell a portfolio of products to a broad base of customers, on any given day there’s a mix of which customers are buying what products. Because each product and customer has a different profit margin, this mix will impact your overall profitability. Even if you have identical revenues in June and July, if your product or customer mix is different one month, your margins will be different, too.
The Key to Understanding Profitability
To understand your profitability, you need to understand your mix. The challenge, though, is that most companies lack the ability to track and measure mix. In particular, highly complex businesses that may have thousands of products and even more customers are often simply not set up for analyzing mix separate from price and cost.
As a result, you might be able to see the big picture – that profits are going up or down – but you may lack insight as to why margins are the way they are, or how to change them. No one wants to have to admit to a board of directors, “Margins went down, but we can’t really tell you the details. We think it was due to bad mix.”
Fortunately, there’s a better way. There is real math that can take place to measure and analyze a mix change and precisely define how that change impacted profitability – which in turn can shed light on what can be done about it. By being able to put a real dollar amount to the impact that mix has on your margins, you finally gain an accurate understanding of how your business is changing over time. And this insight can lead to more informed, appropriate pricing strategies moving forward.
What Is Driving the Change?
Of course, if it’s a one-time event, most likely no change in strategy is needed. But what can be more revealing is the subtle trend over time.
We worked recently with a distributor that sells building materials to home improvement stores. Smaller products like caulking or adhesives tend to carry higher margins, whereas heavier products like drywall or lumber tend to be less profitable. Over the course of several years, their product mix had shifted subtly but measurably toward the heavy products. The change was inconspicuous enough that no red flags had been raised. And yet, the mix change had produced a definite decrease in profitability.
By measuring your mix, you can dive into the details of trends that have been occurring. What has been causing the change? Was it product mix? Customer mix? If it’s an ongoing trend, you’ll want to either accept the change and plan for it in future forecasts, or decide if you want to influence it.
Making Strategic Decisions
Another client we work with was experiencing significant sales increases but declining overall profitability. After taking a closer look at their mix, we realized that a single sales manager was being extremely aggressive with promotions. His sales numbers were skyrocketing, even as his profitability was plummeting. This company needed to find a better balance. How could they strike a balance between top line revenue or bottom line profits?
For a service company, mix might be tied closely with staffing levels. For instance, in a legal firm, litigation might have a very different profitability than contract reviews. By understanding this, a firm can make big-picture hiring decisions designed to grow or shrink certain parts of a practice in order to build a more profitable mix of services over the long term.
Ultimately, understanding and managing mix becomes a major strategic factor that can set the stage for determining how you want to move your business forward. The key to all of this is to have the right technology in place to be able to absorb and analyze all of the data that is associated with mix. However, the upside is enormous – facilitating deeper conversations than ever before possible about the patterns you’re seeing, the drivers behind the change, and the actionable insights that will allow you to optimize the impact on profits.
To learn more about measuring mix with the DRIVE2PROFIT pricing business application, watch this video