In today's highly competitive environment, profitability control is a crucial control to put in place in your company at the start of the year.
In my earlier article on Marketing Controls, I talked about Annual Plan Control, which examined achievements of the planned results for sales, profits and other goals. Another important control to put in place in start of the year is
This is simply because profit is like money in the bank. For a bootstrapped company, profit may be the corporation’s only capital. For an invested company, financing can be used to sustain a company for a certain period of time but ultimately it is a liability, not an asset. Therefore businesses need to analyse the profitability of their various products, regions, customer groups and channels.
Past research over the years has shown that:
- 20-40 percent of a company’s products are unprofitable and up to 60 percent of their accounts generate losses
- More than half of customer relationships are not profitable. Also, 30-40 percent are only marginally profitable. More often than not, a mere 10-15 percent of company’s relationships generate most of its profits.
The methodology of Marketing-Profitability Analysis consist of primarily three steps:
- Identifying the functional expenses
The company needs to determine the expenses being incurred for the marketing activities such as selling, advertising, distribution, packing, billing, and collection, et al. Next task is to break each expense and allocate it to different marketing functions. For example, if most salary went to sales representatives and rest went to advertising manager, packing, office accountant, then the total salary will be allocated according to these activities. Finally, all the natural expenses of salary, rent, etc are mapped onto each functional expense of say, selling, advertising, billing, etc.
- Assigning the functional expenses to the marketing entities
The next step in the Marketing-Profitability Analysis is to measure how much functional expense is associated with each type of channel. For example, based on the number of orders placed through each channel, the company can allocate accounting expenses. Also, based on the number of ads placed for each channel, the advertising expense can be allocated. This way an average cost can be calculated based on the total number of ads. Based on the amount of sales efforts required for each channel, the cost for the sales calls can be allocated to the specific channel.
- Preparing a profit-and-loss statement for each marketing entity
The last step is to prepare a profit and loss statement for each type of channel. The cost of goods is assigned according to the number of sales for each channel, e.g. if one channel achieved half of the total sales then the cost of goods allocated to that channel will be half of the total cost of goods sold.
From this gross margin, one can deduct the proportion of each of the functional expenses including selling, advertising, billing, packing, etc. This overall calculation will give the net profit for each of the channels. The key inference from this calculation is that the gross sales from a specific channel does not equate to a higher profit from that same channel.
While determining the correcting action based on the profit and loss statement, the company also needs to consider factors related to buyers, market trends, marketing strategies, etc. before concluding which channels are the best to continue investing in and which channels need to be dropped. Marketing management can evaluate alternative actions more specific to the channels that are not doing so well.
Costing is one of the important factors where arbitrariness in the choice of bases, calls for adding the judgmental element as well.
For example, while allocating selling expense, a company uses the number of sales calls, when in principle it should use “number of sales working hours.’’
The more serious judgmental element affecting this analysis is an allocation of ‘’full,’’ ‘’direct,’’ and ‘’traceable’’ costs. It is worthwhile to add few definitions as below:
Using direct cost in the Marketing-Profitability Analysis is a no-brainer and there is a small amount of controversy regarding the inclusion of traceable common costs. The major controversy is regarding the allocation of non-traceable common costs, in which case it is known as the full-cost approach. In order to analyze true profitability, all costs must be assigned to the various marketing entities.
Overall, the Marketing-Profitability Analysis gives the relative profitability of the different channels, products, territories, customer groups, et al. It certainly does not prove that a company needs to drop the unprofitable marketing entity nor does it tell that the company will be more profitable if these entities are dropped.
In today's highly competitive environment, Profitability Control is a crucial control to put in place in your company at the start of the year.
In future articles on this same topic, I shall share details on Efficiency Control and Strategic Control, the other two Marketing Controls which every company should put in place in the start of the year.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)