Product Profitability Analysis: Definition & Examples

Instructor: Martin Gibbs

Martin has 16 years experience in Human Resources Information Systems and has a PhD in Information Technology Management. He is an adjunct professor of computer science and computer programming.

This lesson will discuss profitability on a per-product basis. We will define product profitability analysis, provide examples, benefits and disadvantages of the process.

Product Profitability Analysis

Profit is what you have left over after accounting for all expenses/costs of a product. Let's say your company makes office staplers of all shapes and sizes; after all expenses, you clear 18%. That means that you clear 18 cents per dollar of revenue.

But what if you want to know more details specific to your Red Line of staplers?

Product profitability analysis ties costs back to a product (e.g., Red Stapler), and matches revenues to that specific product. When you run the analysis, you will likely discover an interesting phenomenon: 80% of sales come from 20% of your customers or products.

It doesn't mean we stop focusing on the products that don't earn us money, in fact, we can use product profitability analysis on those products to determine next steps for improving profit margins on those products.

Remember that profitability analysis ties revenues and costs to each product. We'll continue with our Red Line stapler product. The Red Line is only one product in a line of many; we will need to separate all revenue and expenses for this particular product in order to analyze our profitability.

Revenue Source Revenue
Target Stores 32,005
Staples 19,250
Office Barn 3,455

Expense Source Expense
Packaging 8,354
Marketing 2,225
Additional Labor 505

Although we usually spread labor costs across all products, we could tie specific labor costs to this product. Let's say it takes our assembler, Milton, one extra hour every week to complete a special feature of the Red Line stapler.

Advantages

The analysis tells us the true costs of our Red Line stapler and we found our hidden labor cost. Maybe we can reduce or eliminate the hidden labor cost to give Milton extra time for producing more staplers.

Now that we have the hard numbers, we can evaluate the product and its true margins. This data guides us in decisions for marketing, product placement, etc. We have pretty lackluster sales at Office Barn; do we need to stop selling there?

The data also allows us to develop different scenarios for the product. For example, we could evaluate how changes in the product price charged to specific retailers would impact our profit margin. All of this can be done based on the data at hand, and not through costly trial-and-error in the industry.

We may also be able to discover areas where we can adjust the price up or down to positively impact the margin. Or, we discover that we can offer a large retailer a significant discount on our product while still maintaining desired margins. Without detailed product data, we can't do this.

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