Not understanding which products are really profitable leads to many arguments!

It is not unusual for different members of a management team to have different views about which are the star products and which are the dogs. The sales function is influenced by the money they can get for the products - so higher priced items are favoured. Operations are influenced by the ease of manufacture – so those that are easier are favoured. If the purchase function is asked – they prefer the products with lower material cost – their budget goes further! Finance can be pressured to produce supporting calculations that will prove one view or another.

How do we tell which products are really profitable for us?

This is not achieved by calculating detailed costing on every step of the production and delivery process. Under Throughput Accounting we adopt the paradigm that the cost that varies by product is only the totally variable cost (TVC). This means mainly the material content, any packaging and commissions which we incur if we sell one more of a product. All other costs are fixed – whether we sell one more or 100 less – they remain the same.

So take a list of your products and record the selling price (don’t forget to deduct any standard discounts given to customers) next to each product. Establish the TVC for each product and add this to the list. The difference between the selling price and the TVC is the Throughput per product. If the company doesn’t have a major bottleneck resource within its process (this means consistently far more orders than the resource can possibly handle) – then – the list is good enough to show that the products with the greater Throughput are more profitable for the company.

If the company does have a major bottleneck resource within its process – then – divide the Throughput per product by the time used by the bottleneck to calculate a Throughput per Bottleneck minute. The more money we get for each minute of bottleneck usage the more profitable each product is.

Get Sales to focus on the most profitable!