1、Author: Gisele Garraway,Contributor: Steve Berez,Profitability,Product Line,March 1998,2,CU7020998JZA,Product Line Profitability,Agenda,PLP overview Applications PLP steps Client example Challenges Key takeaways,3,CU7020998JZA,PLP overview Applications PLP steps Client example Challenges Key takeawa
2、ys,Product Line Profitability,Agenda,4,CU7020998JZA,Product Line Profitability,PLP Description,Product line profitability (PLP) is a diagnostic tool that helps us determine the “true” profitability of each product within a multi-product portfolio.,Picture Frames,Operating Margin,2.3%,5.3%,7.0%,10.0%
3、,5,CU7020998JZA,Product Line Profitability,Profit Improvement Tools,PLP analysis is one of the Bain diagnostic tools that can identify sources of profit improvement.,0%,5%,10%,15%,20%,0.1,0.2,0.5,1,2,5,Profitability,Relative Market Share,Bain profit improvement tool kit,PLP BDP RCP VMR,6,CU7020998JZ
4、A,Profit Line Profitability,Why Bain Uses PLP,Senior managers can use PLP analysis to make important decisions about product lines.,For which products should we increase prices? Where should we focus our cost reduction efforts? Which product lines should we drop? Which products should we focus R&D e
5、fforts on? Where should we provide sales incentives?,7,CU7020998JZA,Product Line Profitability,Typical Accounting System Versus Bain PLP,Unlike typical accounting systems, PLP involves driving below gross margin and allocating costs to get to an operating margin for each product line.,Typical accoun
6、ting system,Bain PLP,Cost collection:,By function (e.g. R&D, advertising),By product line,Cost assigned to products:,Cost of goods sold direct labor direct materials,All costs, including all indirect costs overhead advertising distribution,Key product profitability measure:,Gross margin (revenue - c
7、ost of goods sold),Operating margin,Cost allocation method:,Accounting standards,Activity-based cost drivers,Disadvantage:,Often does not reflect true commitment of resources and the returns for their use,Difficult to capture all activities that drive costs,8,CU7020998JZA,Product Line Profitability,
8、Direct and Indirect Costs,Traditional accounting systems often allocate only direct costs, not indirect costs, to products. And, in some cases, the direct costs are allocated inappropriately.,Indirect costs,Direct costs,Definition,Typical accounting allocation,PLP allocation,Costs generally incurred
9、 by the firm outside of the production process. These cannot easily be identified with or assigned to a particular product,Costs incurred directly in the production of the product or service. These costs can easily be identified with a particular product,Not allocated or allocated based on percent o
10、f sales,Allocated based on actual cost drivers,Tracked using accounting standards Variances sometimes not tracked by product,All direct costs, including variances, are tracked by product,9,CU7020998JZA,Product Line Profitability,Inappropriate Direct Cost Allocation,Some accounting systems allocate d
11、irect costs to products based on original expectations about production results. These assumptions cannot account for changes in raw materials use and labor time.,Accounting standard,Actual for last quarter,Difference,Revenue per widget:,$6.00,$6.00,Raw materials:,$1.75,$1.93,Standard excludes loss
12、Increased loss due to change in supplier quality,Production floor labor:,0.30 hours x 8.00/hour = $2.40,0.45 hours x 8.00/hour = $3.60,Standard excludes switch- over from main produce Increased labor due to rework from lost,Gross margin:,6.00 - (1.75 + 2.40) = 1.85,6.00 - (1.93 + 3.60) = 0.47,Gross
13、margin percent:,31%,8%,10,CU7020998JZA,Product Line Profitability,Gross Margin Versus Operating Margin,If accounting systems do not allocate all indirect costs to products, managers may misjudge products relative contribution to profits.,Indirect costs,Price:,$750,$600,$450,Gross margin:,40%,33%,44%
14、,Operating margin:,29%,20%,23%,On a gross margin basis, J-88s are the most profitable; however, T-54s are most profitable when all indirect costs are allocated,11,CU7020998JZA,Product Line Profitability,Potential for Mismanagement,Failure to tie direct and indirect costs to individual product lines
15、can cause firms to mismanage their businesses.,Sales and marketing,Distribution,Product development,Spend advertising dollars on wrong products Set up compensation and incentives to encourage sales of unprofitable products,Prioritize delivery schedules inappropriately Establish wrong truck load rati
16、os,Fund unprofitable products Kill profitable products,12,CU7020998JZA,Product Line Profitability,Paths to Low Profitability,Multi-product businesses that do not understand their products true profitability become low profit firms.,If gross margins are based on inappropriate accounting standards and
17、 indirect costs are not allocated appropriately,High gross margin (potentially low net profit) products are given investment capital,Low gross margin (potentially high net profit) products are starved of investment capital,New product line extensions are introduced,Additional complexity from growing
18、 number of SKUs increases direct costs,Product line extensions are ignored and profitable products growth slows,Poor profitability continues, driving high prices and poor positioning versus competitors,13,CU7020998JZA,PLP overview Applications PLP steps Client example Challenges Key takeaways,Produc
19、t Line Profitability,Agenda,14,CU7020998JZA,Product Line Profitability,Applications,Bain has used PLP extensively. Some examples of our work include:,Air transportation,Communications,Situation:,An air transportation company had various lines of business, but no activity-based accounting system. Man
20、agement did not know which businesses, routes, or customers where profitable,After suffering four consecutive years of negative net income, a voice processing service company was interested in understanding the economics and market positioning of their product lines,Result:,Bain identified unprofita
21、ble businesses, routes, and customers which in some cases were subsequently cut or pricing was altered to improve profitability. An analysis of costs indicated that profitability was much worse than thought, leading to a mandate for company-wide cost reduction and revenue enhancement,Bain assessed t
22、he profitability of three major product lines and identified savings of $20-$25MM on a cost base $110MM,15,CU7020998JZA,PLP overview Applications PLP steps Client example Challenges Key takeaways,Product Line Profitability,Agenda,16,CU7020998JZA,Product Line Profitability,PLP Steps,PLP analysis invo
23、lves six major steps.,Understand clients current P&Ls and cost collection systems,Determine the major activities performed,Identify costs and cost drivers for each activity,Allocate costs to each product,Analyze profitability by product or group of products,Make recommendations,Key Success Factors,I
24、dentify all people and systems that report financial data Understand linkages among and differences between the various sources of data,Tie costs to operations, not accounting categories Focus on the largest cost elements,Quantify drivers for each product,Pressure test assumptions with clients Calcu
25、late over several years or periods to eliminate any seasonal or one-time effects Make sure absolute profit of product lines can be reconciled with the total business profits,Consider strategic and operational alternatives,Map the clients value chain from beginning to end,17,CU7020998JZA,Product Line
26、 Profitability,Kellys Gourmet Jellies - Background,PLP could be used to help Kellys Gourmet Jellies understand the profitability of its jar versus bucket business.,Situation:,Kellys Gourmet Jellies is a regional producer of high-quality, premium priced fruit jellies. Kellys has two major product lin
27、es: 8-oz jars to grocery stores for retail sale and 1 gallon buckets to universities, hotels, restaurants, and country clubs,Complication:,Indirect costs are not allocated to products,Question:,Are 8-oz jars more profitable than gallon buckets?,18,CU7020998JZA,Product Line Profitability,PLP Steps,Un
28、derstand clients current P&Ls and cost collection systems,Determine the major activities performed,Identify costs and cost drivers for each activity,Allocate costs to each product,Analyze profitability by product or group of products,Make recommendations,Key Success Factors,Identify all people and s
29、ystems that report financial data Understand linkages among and differences between the various sources of data,19,CU7020998JZA,Product Line Profitability,Kellys - Sources of Cost Information,An important first step in PLP analysis is understanding the clients financial reporting system.,Order datab
30、ase,Contents,Report Timing,Responsibility,Quantities of jars ordered by customer Quantities of buckets ordered by customer Price per order,Weekly,Marketing/sales analyst,Monthlymanufacturing summary,Ounce production by flavor Employee time reports,Monthly,Kitchen supervisor,Expense report/vendor pay
31、ments system,Storage inventory Ingredient invoices Utility payments,Monthly,Accounting analyst,20,CU7020998JZA,Product Line Profitability,Kellys - Current Profit Reporting,Kellys current accounting system shows that on a gross margin basis, 8-oz jars are more profitable than one gallon buckets. Over
32、all, Kellys earns a 9.4% EBIT margin.,Sales:,$468,000,$252,000,Gross margin:,$243,360,$105,840,Kellys Gourmet Jellies Profit and Loss Jan-Dec 1996,Sales,Cost of goods sold,Gross margin,$720,000,($370,800),$349,200,Operating expenses,($281,334),EBIT,$67,866,EBIT margin,9.4%,21,CU7020998JZA,Product Li
33、ne Profitability,Kellys - Operating Expenses,Over $280K of operating expenses are not allocated to jars or buckets.,LaborKitchen maintenanceAdministrativeWarehouseDelivery Sales commission Maintenance supplies - kitchen Maintenance supplies - trucks Utilities - kitchen Utilities - warehouse Deprecia
34、tionKitchen equipmentWarehouseOffice equipmentDelivery equipment Selling expenses Other G&A,$5,955 $12,262 $6,590 $15,880 $56,880 $5,955 $1,985 $3,375 $12,706$26,206 $7,624 $2,621 $11,117 $79,413 $31,765 $281,334,22,CU7020998JZA,Product Line Profitability,PLP Steps,Understand clients current P&Ls an
35、d cost collection systems,Determine the major activities performed,Identify costs and cost drivers for each activity,Allocate costs to each product,Analyze profitability by product or group of products,Make recommendations,Key Success Factors,Map the clients value chain from beginning to end,23,CU70
36、20998JZA,Product Line Profitability,Kellys Jellies - Process Flow,Typically management interviews and plant tours help delineate the key activities that drive costs.,24,CU7020998JZA,Product Line Profitability,PLP Steps,Understand clients current P&Ls and cost collection systems,Determine the major a
37、ctivities performed,Identify costs and cost drivers for each activity,Allocate costs to each product,Analyze profitability by product or group of products,Make recommendations,Key Success Factors,Tie costs to operations, not accounting categories Focus on the largest cost elements,25,CU7020998JZA,Pr
38、oduct Line Profitability,After key activities are determined, all costs should be assigned to activities. Next, the cost driver will determine how costs should be allocated.,Activity,Costs,Allocation/cost driver,Rationale,Preserving,Maintenance labor Maintenance supplies Utilities - kitchen Equipmen
39、t depreciation,$5,955 $5,955 $3,375 $26,206 $41,491,Ounces,Both products use the same jelly, so ounces is the best proxy for relative use of equipment and facilities,Boxes of jars and buckets can be stacked on top of each other,Storing,Warehouse labor Utilities - warehouse Warehouse depreciation,$6,
40、590 $12,706 $7,624 $26,920,Cubic feet,Kellys - Cost Drivers,26,CU7020998JZA,Product Line Profitability,Activity,Costs,Allocation/cost driver,Rationale,Total operating expenses:,$281,334,Kellys - Cost Drivers,27,CU7020998JZA,Product Line Profitability,PLP Steps,Understand clients current P&Ls and cos
41、t collection systems,Determine the major activities performed,Identify costs and cost drivers for each activity,Allocate costs to each product,Analyze profitability by product or group of products,Make recommendations,Key Success Factors,Quantify drivers for each product,28,CU7020998JZA,Product Line
42、 Profitability,Kellys - Cost Driver Collection,Next, the key cost driver measures for each product must be collected to determine how to allocate costs among the products.,Ounces produced and sold:,8-oz jars,One gallon buckets,Total,Data source,1,248,000,1,075,200,2,323,200,VP, sales,Labor hours req
43、uired to deliver 1MM oz of jelly:,24 hours,10 hours,Delivery supervisor track schedules,Average warehouse storage requirements:,3,100 cubic feet,1,900 cubic feet,5,000 cubic feet,Stock supervisor,Sales commissions:,8.1% sales,4% sales,VP, sales,Selling/promotional expenses:to retail (jars only)to in
44、stitutions (buckets only)to public (jars and buckets),73,795,1,638,VP, sales,3,980,29,CU7020998JZA,Product Line Profitability,Kellys - Cost Allocation (P.1),*Total costs for activity minus the costs allocated to jars,Once cost driver measures are collected for each product, it is relatively straight
45、forward to allocate costs.,Sales: COGS: Gross margin:,8-oz jars,One gallon buckets,468,000 224,640 243,360,252,000 146,160 105,840,Preserving costs:,1,248MM oz/2,323MM oz x 41,491=22,290,41,491 - 22,290=19,201*,Storing costs:,3,100 cu ft/5,000 cu ft x 26,920=16,690,26,920 - 16,690=10,230,30,CU702099
46、8JZA,Product Line Profitability,Kellys - Cost Allocation (P.2),8-oz jars,One gallon buckets,Delivery costs:,1,248MM x 24hrs/MM oz /(1.248 x 24) + (1.0752 x 10) x 28,982 = 21,327,28,982 - 21,327=7,655,Selling:commissionpromotions,468,000 x 10%=46,800,252,000 x 4%=10,080,73,795 + (1.248/2.323) x 3980
47、- 75,933,1,638 + (3,980 - 2,138)=3,480,Corporate overhead:,1.248/2.323 x 47,648=25,598,47,648 - 25,5978=22,050,Total operating expenses:EBIT,208,638,34,722,72,696,33,144,31,CU7020998JZA,Product Line Profitability,PLP Steps,Understand clients current P&Ls and cost collection systems,Determine the maj
48、or activities performed,Identify costs and cost drivers for each activity,Allocate costs to each product,Analyze profitability by product or group of products,Make recommendations,Key Success Factors,Pressure test assumptions with clients Calculate over several years or periods to eliminate any seas
49、onal or one-time effects Make sure total absolute profit can be reconciled with clients calculations,32,CU7020998JZA,Product Line Profitability,Kellys Jellies - PLP Results,PLP results revealed that one gallon buckets are more profitable than jars.,Current Accounting System,PLP,Buckets have:,Lower warehousing costs Lower promotional costs Lower selling commissions Lower labor costs in stocking and delivery,33,CU7020998JZA,Product Line Profitability,
