Contributionmargin
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This document discusses contribution margin analysis, which analyzes the profitability of various parts of a business like customers, products, and sales areas. It provides an example of a company that used contribution margin analysis to categorize its customers into four groups - solid citizens, attractive demanders, players, and risky losers - and was able to improve profitability by focusing more on the solid citizens and less on the risky losers. The document recommends that all businesses use contribution margin analysis to help make better strategic and tactical decisions.
Contributionmargin
- 1. Global Marketing, Inc. … expanding your market, extending your leadership! A little used, but effective business tool - Contribution Margin Analysis One report every business owner waits to see is the monthly income statement. There is nothing wrong with this, but the traditional income statement usually won’t supply you with enough information to direct business decisions that enhance your operation. Which customers are most profitable? Is the commission or bonus structure in each sales area correct? What products are providing the best return? To really understand the answers to these questions you better get acquainted with an important, yet simple tool called -- margin contribution analysis. What is it? In simple terms it is the leftover (as a percentage) of each sales dollar after variable costs are covered to serve the account, product or service. Decisions related to pricing, product life cycle management (see Marketing Tip # 106 – Product Life Cycle) and sales bonus/commission structure can more confidently be assessed while driving net operating income to the desired level. Computing margin contribution is easy and your CPA or accounting group should be able to quickly set up a proforma format. Depending on your firm’s size and financial sophistication, you may already have some form of this analysis, but here is a typical statement example: © Global Marketing, Inc.
- 2. Global Marketing, Inc. … expanding your market, extending your leadership! The above points out that Widget Company’s contribution margin is 35.8%. This means that, for every sales dollar, after cost directly related to the sale (costs-to-serve) are subtracted, 35.8 cents remains to contribute to paying fixed costs and adding to net operating income. Applied across the business, one should readily see how contribution margin analysis could be immensely helpful in both strategic and tactical decisions related to products, customer types and distribution incentive programs. Real-life example After implementing a contribution margin analysis on its customer database a recent Global Marketing client found that just because the customer generated the most sales, didn’t mean it was good, profitable business. Global Marketing was able to help categorize the firm’s customers into four basic types. With slight changes these groups might help your business too. The matrix became a useful tool in managing customers, annual business planning and maximizing the return to the corporation. Let’s start in the upper left-hand corner. This square contains accounts most profitable to the firm. We termed these customers Solid Citizens. Once visible, the owner decided he would ensure his organization paid particular attention to the wants and needs of these purchasers. © Global Marketing, Inc.
- 3. Global Marketing, Inc. … expanding your market, extending your leadership! The next box held accounts we dubbed Attractive Demanders. These were customers that the firm thought they should do business with, but after analysis, due to the cost-to-serve, were determined to be less profitable. It still made sense to do business with some, but choosing accounts wisely became the guiding tactics. The next box called Players was interesting. These were accounts that tended to spend lots of time with his sales people, but invariably picked price over value. Sure they claimed they wanted both, but always made decisions based on lowest price. And what made these accounts even worse is that each time he would have to resell the account, so repeat business (where most account profit comes from) was limited. Contribution analysis made the cost-to-serve these accounts more visible. Therefore, he would have his sales people review, but not get trapped by the volume or name brand of the account. Sales effectiveness went way up. And finally the least profitable of all customer types became known as --Risky Losers. This was a dangerous category because the accounts looked healthy to the average sales person. Usually these were potentially larger volume accounts, but in the end required huge amounts of pre and post sales support. Because of their volume the potential customer felt he had the clout to ask for a new contract each time. Tight pricing, higher discounts and added extras resulted in lower margins. The firm moved away from these accounts. Improved effectiveness, higher sales efficiency and enhanced growth potential resulted from knowing what accounts generated the best return for his organization. Contribution margin analysis helped this firm get focused on things that matter. Inserting a tool that makes a difference Why not utilize this tool in every aspect of your business. More quickly determine product winners from losers, or adjust your pricing structure based on actual margin results or decide which geographical area is really returning the most margin. You can keep track, on a regular basis, and trend results to objectively reward sales people or adjust commissions to motivate regional or product performance. The flexibility gained is tremendous. Annual planning sessions become easier. Contribution margin analysis can factually report period-to- period results by product, region, sales person, or any area of the company. Year-on-year trends indicate if your plans are effective. This is one of the most important business tools available. It’s easy, effective and costs almost nothing to implement. Don’t delay, insert this tool today! © Global Marketing, Inc.