ABC or activity-based management (ABM) can help to reduce a company’s overall cost structure by as much as 3% to 5%. An enhanced focus on higher margin and growth products and the pursuit of better markets can interpret a 5% to 15% increase in revenue.”
All businesses have one object, improving profitability and reducing cost. Many retailers concentrate on cost of goods sold (COGS) and gross margin, and don’t know their real cost at a product or product grouping level, nor how to effectively manage pricing and net margin.
To understand a product’s real profitability (net profit) is to use an ABC method—which still isn’t widely used. ABC involves determining cost to serve at the product or product classification level. In a competitive environment, it’s imperative that you make decisions based on real net product profit knowledge and associated knowledge.
Retailers often look at gross margin that hides a multitude of facts because some products or product categories have far higher cost to serve (C2S). C2S can be defined as all costs apart from COGS or the consolidation of the costs that are attributed to the product on its journey from receipt at the retailer’s back door from vendors (or origins) through the processes on the supply chain route, to the consumer (sometimes via stores), plus administration.
Relatively, small number of products generates the bulk of margin (sometimes called the 80:20 rule—where 20% of the products give 80% of the margin).
The real contribution to net margin can be broken into three segments:
• Profit-creating products that generate the majority of the net margin. These products usually have low C2S.
• Non profit-creating products are some mid-tier products that neither add to nor reduce margin levels significantly.
• Profit-destroying products are those products that generate the largest losses in the range/assortment.
The difference between the cumulative gross margin and the net margin is cost to serve. Clearly in terms of the profit-destroying products, it’s the cost to serve that causes the net loss. For these products, the effect is that for every sale made, they are eating away at net profit of the retailer. The provision of this information should stimulate a number of change initiatives to reduce product cost or remove product from the assortment that can quickly bring improvements in the bottom line.
It’s not always necessary to remove all profit-destroying products from a category assortment—sometimes they are loss leaders or important to category consumer credibility. The net profitability of a product can be improved through:
• Revising the selling price
• Help via subsidization from suppliers or vendors in terms of rebates, allowances, shelf share protection subsidies, etc.
• Improved cost to serve through reducing process cost in supply chain administration
If it’s obvious that none of these improvements can be made, then the products should usually be removed from the assortment. In these cases, retailers usually need to source replacements (new products) that provide greater net profit before exiting the profit-destroying products—as even profit destroyers cover business costs.
Leveraging net profit
The most effective methods of improving net profit are through effective selling-price management and reducing variable costs.
Generally, in a price-competitive retail market, pricing decisions are the result of the following factors:
* Reducing variable cost is inevitably one of the key ways retailers improve net profit.
* Improving product mix in assortments
* Reducing product store handling costs
* Reducing product warehouse handling costs
Consider while Maneuvering a Supply Chain-
• Net profit insights can help in pricing decisions
• Drive efficiency while maintaining service levels
• Increase negotiation power with trading partners
Retail benefits achieved through understanding true product cost (including cost to serve) and net profit by dimensions include:
• Category assortment’s product composition, designed considering net profit. Adjust the net profitability of assortment by improving the product mix by including higher profitably products. This includes replacing unprofitable products with more profitable ones.
• Improved pricing and discounting partially through knowing real cost (including improved price elasticity indices). More definable, consistent, and better-understood pricing execution across the entire business.
Increase profitability Channel/Supply Chain thru:
• Evaluation of channel structure
• Evaluate stockholding of packaging
• Assess cost to serve by supply chain
• Increase incentive for sales channels
• Understand irregularity between distribution channels/supply chains Product
• Apprise all profit destroyers
• Analyse all products by net profit
• Identify opportunities for reducing cost of bought aligned Vendors
• All cost lucidity in vendor negotiation
• Focusing on less profitable vendors
• Collaboration with vendors to develop processes and cost
• Cost impact of alternative sources, supply configurations etc.
• Lever product distribution by supply chains with lowest cost to serve
• Review minimum array quantities
• Develop target costs for ware-housing
• Templates for supplier negotiation relating to process & collaboration
• Develop space strategy based partially on net profit criteria Data
• Incorporate rebates in ERP system
• Produce laptop pricing model Customer
• Review customer groups who place multiple small orders
• Evaluate A- and B- Customer-groups
• Deem minimum order value for customer groups
• Judge customers inexpensive to serve areas viability
So take a leaf from ABC, fuel the fires of your business and take it to greater heights...