High sales do not always translate into healthy profits. A popular product could produce disappointing returns after you account for discounts, shipping, returns, and support costs. At the same time, a lower-volume product could quietly generate a healthy profit margin.
How can you tell what is working? Product-level analysis may help show where your business is generating profit and where high revenue may be masking weaker performance. This can be useful whether your business manufactures, distributes, or sells products through sales reps, online channels, or brick-and-mortar stores.
Calculating The Full Cost
Start by identifying each of your product’s direct costs, such as materials, inventory purchases, production labor, and packaging. Then consider expenses that might be easier to overlook, including:
- Freight, warehousing, and inventory carrying costs
- Sales commissions
- Payment-processing charges
- Promotions and discounts
- Returns, spoilage, and shrinkage
- Customer service and technical support
Overhead expenses — including rent, insurance, technology, and administrative salaries — also affect product profitability. However, allocating them solely by sales volume can distort results.
A product that requires, for example, customized packaging or extensive customer support should receive a greater share of those costs. Activity-based costing can provide a more realistic view by assigning expenses according to the activities that generate them.
Beyond Gross Margin
No single measurement tells the whole story. Gross margin shows how much revenue remains after covering cost of goods sold. Meanwhile, contribution margin subtracts variable costs from revenue. A positive contribution margin generally means a product helps cover fixed expenses and generate profit.
So, if a product appears unprofitable after allocated overhead, don’t automatically discontinue it. Because many fixed costs will remain, eliminating the product could reduce your business’ overall profit. Instead, consider whether the product attracts new customers or supports sales of more profitable items.
Also evaluate product profitability by sales channel and customer segment. The same item may be profitable in a store but lose money through an online marketplace because of commissions, fulfillment expenses, and returns. In a similar vein, a large customer’s discounts could erase the benefit of high sales volume.
Turn Findings Into Action
Reliable product data can support better pricing, purchasing, marketing, and inventory decisions. It can also help you negotiate supplier terms, adjust sales and distribution channels, and evaluate new products.
Product-level analysis shouldn’t be a one-time exercise. Market and economic conditions often change, so you should review margins regularly and investigate major variances. Also contact us. We can help you develop a practical approach to turning product data into profitable decisions.
