35. Analyze Price and Profitability by Product and Service
Working with companies both large and small over the years, I have noticed that a lot of time and attention is invested in developing marketing strategies without fully understanding the internal costs and profitability of the products or services being sold. It’s surprising—shocking, actually—that so few business professionals understand their costs and margins. In Section VI, “Execute and Evaluate,” we will explore new, more efficient methods of budgeting and forecasting that are cross functional across operations, finance, marketing, and sales. For now, let’s make sure we have at least the basics in place.
The purpose of the exercise is to help you understand how you can increase profitability across your product and service lines. This evaluation must be done before you develop your pricing strategy. If you are a marketer who breaks out in hives at the very word of “finance” or “budget,” don’t worry. The process you are about to learn is made just for you. It’s simple and easy to understand. Please note that the next form and several others are available for you to use in the Real-Time Marketing for Business Growth book resources section at www.MarketSmarter.com. The exercises and forms are designed to work together to allow you to “plug and play” different variables to analyze price and profit points.
Marketing Tip for Large Company
If you are a marketing professional in a large company, your finance team should be able to provide you with the information you need to understand the cost, revenue, and margin on a per-product and service basis. If not, now is a good time to work with others in your company to fully understand this information.
Revenue/Cost Analysis
The revenue/cost analysis worksheet summarizes recent sales history and variables impacting sales. Two simple examples are provided to help you understand a product business (Tony’s Surf Shop) and a service business (Larry the Lawyer). The goal of the sales budget is to calculate revenue, profit, and contribution to revenue on a per-product and service basis.
The worksheet will ask for fixed costs and variable costs. Fixed costs are costs that continue regardless of the volume of sales. Rent, salaries, insurance, interest charges, and property taxes are examples of fixed costs. Variable costs are costs that fluctuate based on production and sales volume. In retail business, they may include freight, commissions, shipping, and handling. In manufacturing, the variable costs might include molds, assembly, cleanup, set up, and freight. In service businesses, commissions, consulting, or contractor fees used in providing a service are examples of variable expenses. Some service companies allocate costs as a percentage of the service’s revenue contribution to overall revenue. Others choose to allocate costs based on time spent on projects. Work with your accountant or finance team to make a list of the fixed and variable cost items so there is agreement about what costs go where. Explain your objectives to the finance team so they can understand your goal is to make marketing decisions on a per-product and service basis.
If you have a new company that does not yet have a sales history, the budget will be based on projections. Consider using industry standards from your industry association or from Risk Management Association’s (RMA) Annual Statement Studies.1
The following worksheet summarizes the income and costs for both the product and the service businesses. The examples reflect two small businesses and are intentionally simple to explain the concept. The same methodology can be applied to any size of business. If you are a marketer in a large company, your finance team can hopefully provide you with the information you need.
The worksheet provide examples for three products or services. It can be easily modified to suit the needs of your business. You will note that there are letters next to each line item. The letters match those in another worksheet titled Target Profit Analysis. Simply plug the numbers from the line items in the Revenue/Cost Analysis worksheet into the line items with the corresponding letters in the “Target Profit Analysis” worksheet. This will give you an easy way to experiment with changing different variables to see how you can achieve a higher profit. Blank worksheets and examples are in the Real-Time Marketing for Business Growth book resource section at www.MarketSmarter.com.
Worksheet
