One thing that every small business owner has to deal with is that they don’t have unlimited access to every type of resource that they need. Whether that be access to cash, labour, raw materials or even space. In order to maximise the returns they make from the business then has to be focused upon how best to allocate the resources they do have to the products and services that will provide the best return.
If you don’t currently undertake product and channel profitability, one of our previous blog posts will be of benefit to you and give you an introduction to the concept. Fortunately, there are means of closing the gap, such as technology, which can allow you to take advantage of the benefits it provides. Improving productivity within your organisation, efficiently and effectively, will allow you to make the best return possible but how do you know where to focus your efforts in order to achieve this.
Gross profit analysis on a product and channel basis allows you to determine where it may be best to allocate resources, but it isn’t the be all and end all. If you have two very similar priced products on the market but one produces 50% margin as opposed to the 40% provided by the other, you may be tempted to throw all of your limited resources at that higher margin product.
However, what if the market is saturated for your product and the allocation of resources doesn’t lead to an increase in revenue. All of a sudden your overall gross profit for that product goes down and you have stock sitting on the shelf, tying up your cash.
On the other hand it could be that the 40% margin product still has quite some way to go before sales would slow down. It is much better to have sales of a product at 40% than have product on the shelf that isn’t selling, no matter the margin (you’d then probably have to sell it at a sale price which would erode the margin anyway).
It is also vital to keep analysing your product profitability so that you can reallocate scarce resources should the need arise. Maybe a large order for a product came in and you have to make a decision on which other products have to have some of their resources rescheduled. This will allow you to calculate the opportunity cost of taking this order and how profitable in will really be.