Understanding Profitable Sales Growth Gets a Little Easier with Price/Volume/Mix Analysis
CEOs and CFOs actively manage product mix strategy – the balance between sales demand, pricing, and volume – to understand what drives revenue changes from period to period. Product mix, however, is often misunderstood and underutilized in making critical decisions on sales growth, particularly for companies with complex product portfolios.
As finance executives seek to explain the core drivers of operating results through price, volume, and product mix analysis, there is also an opportunity to maximize sales growth potential. However, few companies have mastered the process of attaining the full benefits from these analyses.
The management of product mix is often subject to complex cost allocations required to determine contribution margin as well as customer and product profitability. Typically, non-Finance departments such as Sales, Marketing, and Operations view this analysis as overly complex for driving their qualitative business decisions, especially given the complexity of the calculations and underlying assumptions.
While such financial analytics certainly have their value, there exists a simpler solution that is a leading indicator in how to grow revenue and profitability. Business leaders that leverage Price/Volume/Mix analyses are able to more effectively evaluate sales mix and the impact on overall profitability. Such insight can enhance the decision making process and help explain nuances of revenue growth.
A common approach among Finance executives and practitioners is to develop analyses that explain relationships only between price and volume. These provide the framework necessary to disaggregate the drivers of revenue. However, price/volume analyses are not complete until Finance practitioners consider the impact of sales mix. This is particularly important for Luke’s consumer products business where sales demand for specific products and SKUs drive the entire ordering, production, and customer fulfillment process. When the products or services need to be in the right place at the right time, the accurate analysis of product mix, particularly the cost of goods sold for each product and the underlying demand or profitability supporting each product, is critical to close gaps in understanding the quality of revenue growth.
The Data Challenge
Luke is reviewing the key performance indicators (KPIs) in the monthly business review that his operations team compiled for the CEO and CFO. These KPIs include revenue, pricing and transactional metrics – long-time industry standards – that the company has been tracking for years. Over time, management has tracked these metrics and reported them in quarterly earnings updates, discussing them with research analysts and lenders. Given management’s longstanding reliance on these operational metrics to explain performance externally, these KPIs are incorporated into FP&A’s internal monthly Price, Volume, Mix analysis.
Every quarter, Luke meets with the executive leadership team to discuss results in the business review report. When the conversation turns to mix, however, there is no explanation of the underlying drivers for operational decision making. Further, the CEO and CFO routinely see significant changes in mix and are frustrated at the lack of accountability for explaining and improving this metric.
Here are some examples why such explanations may be difficult:
Mix is not the Fall Out
Sometimes mix is categorized as the fall out – explaining changes in revenue after price and volume are incorporated into the analysis. For instance, if revenue grows by 6% and price and volume explain 5% of that growth, mix must account for the additional 1%. This may or may not be true. If there are flaws in how price or volume are determined, the results will unfairly impact the analysis of product mix and potentially result in confusing and misleading trends, making it difficult to make optimal business decisions.
KPIs are Metrics – not a Proxy
The underlying definition of sales and operations-related KPIs illustrating the impact of price and volume on revenue growth may be more focused on measuring internal performance. For example, YoY sales are often evaluated to exclude new stores opened in the past year, ensuring an appropriate comparison on volume and pricing metrics. However, transactions from these new stores are critical in evaluating product mix to understand the underlying impact of historical and projected revenue trends.
Transactional Data is the Key
Classic FP&A analysis relies on inputs such as number of transactions and effective pricing at the transactional level. There may be limited institutional knowledge how to gather reliable information related to these metrics. In addition, transactional data needed by Finance is often considered too voluminous and cumbersome to gather, taking too much processing time and resources to utilize in Excel-based tools and management reports.
Mix is determined by Math, not Intuition
Most organizations are focused on price and volume. Mix is not commonly understood and is often discussed in an anecdotal manner when making product management decisions.
Opportunities for improving profitability are available for Finance leaders willing to dig deeper and transform Price, Volume, Mix analysis from a sales and operations function to a strategic priority across all business units. By providing the right information and analytics, a Finance manager can ultimately improve decision making from the boardroom to field operations.
Incorporating FP&A Analytics
The best way to unlock the opportunity to improve product mix and the quality of revenue is with an approach that integrates FP&A analytics into operational excellence.
Step 1: Identify and Collect the Right Data
Develop a financial data repository to enable an understanding of the interplay between performance metrics and underlying sales-related transactional-level detail. In addition, Finance practitioners should reconcile this data to a “source of truth”. There should be a process to identify outliers, cleanse the data of known anomalies, and create a load process that is sustainable, repeatable, and dynamic enough to manage data anomalies found in the most common financial systems.
Step 2: Understand the Interplay between KPIs and Revenue Drivers
Disaggregate the calculations behind KPIs commonly used to understand sales factors related to pricing and sales volume. Finance should develop a map that provides executive–level understanding of the relationship between these metrics and the aggregation of individual customer transactions that translate into the revenue reported by accounting.
Step 3: Create Front-End Dashboards Empowering Finance to Visualize the Analytics
Create front-end management reporting that provides the power to customize analytics on the fly. Leveraging data visualization tools, Finance should provide information to the front lines or executives via dashboards, enabling real-time customized views of mix analysis by product, customer, division, or store. Such visualization makes mix analysis actionable in driving both tactical and strategic decision making. Additionally, the ability to automate processes containing large amounts of data has created an ease of use that Finance teams have lacked in the past.
Dashboards are a powerful tool to visualize the impact of Price, Volume, Mix analysis. These dashboards can be dynamic, empowering the user to drill into transactional data to better understand what factors are driving the period over period change in revenue.
Step 4: Leverage Analytics to Empower Finance Led Transformation
Supplement the process enhancements and reporting analytics by setting benchmarks and providing incentive programs to induce behavioral changes and cultural shifts that improve mix, not just pricing and volume. This approach incentivizes the desired top line growth – not just a pick-up in volume from selling loss leaders or unsustainable gains from one-time pricing strategies. Truly understanding changes in product mix also yields the benefit of providing senior leadership with the transparency necessary to address related questions from the Board, investors, lenders, analysts, and other key internal and external stakeholders.
Almost every company has areas where sales mix can be improved, creating favorable conditions for managing operational capacity and incentivizing sales teams to target the right opportunities. It requires attention to detail to identify where such opportunities exist and it demands that Finance takes the lead to simplify complex concepts and educate leaders across various business units and functions.