Updated: Monday, November 30th 2020, 9:13:22 am

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Single Product Profitability. The Place To Start!

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This is one of the most overlooked metrics but rather the most important one when it comes to growth. This concept of calculating Single Product Profitability (SPP) is quite common in the finance industry, Telcom, Construction etc. essentially where the revenue generated per product quite significant. But over the years this term has become fairly common in the digital world as well. Now at this point, you have some obvious question like, what’s the difference between SPP and Profit Margin, why should I even care, what is SPP, etc. etc. So, I have written this article to cover all these concerns.

What is single product profitability?

Essentially, it’s the profit you make selling one unit of a product, inclusive of Fixed Costs, Variable Cost, Growth Factor and margin.

Now that’s a lot of jargon for some of you. So, let’s break it down –

Fixed Costs

A fixed cost is a cost that does not change with an increase or decrease in the amount of goods or services produced or sold. Fixed costs are expenses that have to be paid by a company, independent of any specific business activities.

Variable Costs

A variable cost is a company’s cost that is associated with the number of goods or services it produces. A company’s variable cost increases and decreases with its production volume. When production volume goes up, the variable costs will increase. On the other hand, if the volume goes down, so too will the variable costs.

Growth Factor

The rate at which your growth is projected, or you project your growth to be. This is the combination of the time it takes you to hire new people, the time it takes you to produce more stock, the time it takes growth office location, effectively a cumulative of everything that needs to be looked at when you are projecting growth. We will cover this in more detail in a separate article.

Profit Margin

Profit margin is one of the commonly used profitability ratios to gauge the degree to which a company or a business activity makes money. It represents what percentage of sales has turned into profits. Simply put, the percentage figure indicates how many cents of profit the business has generated for each dollar of sale. For instance, if a business reports that it achieved a 35% profit margin during the last quarter, it means that it had a net income of $0.35 for each dollar of sales generated.

How do I calculate single product profitability (SPP)?

This part is slightly tricky, but hopefully, my explanation below helps. At any point, if you think that explanation below is not enough, please feel free to contact me.

The longer you have been in the business the more accurate your SSP is. However, if you are just starting up and need to establish a benchmark, just start with some assumptions. It’s not about getting an accurate result, it’s all about benchmarking and then improving over time.

Pre-requisites – 

Step #1 – Lets calculate total number of products sold in last 12 months.

Step #2 – Calculate total $’s earned in revenue from the products or simply total sales figure ($)

Step #3 – Total # of Head count you had in the business by function over the last 12 months. If you have people coming in and going out, amortized it over the year and 

Also make sure to include your vendors, suppliers and contractors

Step #4 – Do the same for the tools and infrastructure you used over the last 12 months. 

*Try not to be too precise with this. The key over here is to get a basic idea because there are so many factors that can impact the calculations, so there will be a buffer that we will put in towards the end. Also, this number will get better and better over a period of time.

So now let’s take an example of a business for whom we want to understand SPP.

Below we have shown how to gather # of product sold and total revenue from the products ($).

Jan-19Feb-19Mar-19Apr-19May-19Jun-19Jul-19Aug-19Sep-19Oct-19Nov-19Dec-19Total
Total Number of products sold (#)10012011011310610911411614315287781348
Total Earned ($)$34,500$36,800$35,630$32,450$36,540$35,660$34,780$34,670$42,000$44,230$28,910$25,230$421,400
Average Revenue per product ($/#)$345.00$306.67$323.91$287.17$344.72$327.16$305.09$298.88$293.71$290.99$332.30$323.46$312.61

Next step would be to get the fixed and variable resourcing costs –

ResourceResourcesTimeFixedVariableTotal Fixed CostTotal Variable Cost
CEO1100%Yes$4,000
Finance / Accountant1100%Yes$3,500
IT Developer4100%Yes$8,000
Sales2100%Yes$5,000
Service2100%Yes$4,500
Marketing180%Yes$3,000
Advertising1100%Yes $3,000
Total Fixed$18,500
Total Variable     $12,500
Total$31,000 

Now that we have the fixed and variable resourcing costs, lets do the same for tools and systems –

Tools and SystemsResourcesTimeFixedVariableTotal Fixed CostTotal Variable Cost
Server Costs1100%Yes$400
Accounting Softwares1100%Yes$350
Other softwares4100%Yes$800 
Total Fixed$1,150
Total Variable     $400
Total$1,550 

Its now time to do some calculations – 

Per MonthPer Year
Total Fixed Costs(Resource + Tools)$19,650$235,800
Total Variable Costs(Resource + Tools)$12,900$154,800
Total Costs (Resource + Tools)$32,550 $390,600 
Total Fixed Cost Per Product$174.93
Total Variable Costs Per Product$114.84
Average Cost Per Product $289.76
Target Profit Margin + Shareholder Return35%$101.42
Single Product Profitability($78.57)

As you would notice from the above example that the SPP is actually negative, which is quite possible and the next tasks for us is to use this figure and forecast how we can improve this. The problem is not SPP, its actually the growth factor. So let’s calculate the growth factor.

Current Growth Factor 80%

Now the Growth factor should always be above 101%, to show that business is actually moving forward. In order to make the growth factor increase there are few things that play an important part.

Current Growth Factor 80%
Variable to Fixed cost ratio0.66

As a rule of thumb Variable to Fixed ratio should able be above 1

If your business is in this situation there are two things you can do 

  1. Either reduce your fixed costs. 
  2. Sell more products.

Now I recommend you do both, but focus more on the Sell more products.

If I was to do the projection for next two years for this same business, there are things I will put as constant focus purely on numbers –

Current YearYear #1Year #2Year #3
Total Number of products sold (#)1348215734515521
Total Earned ($)$421,400$674,240$1,078,784$1,726,054
Total Fixed Cost$235,800$235,800$235,800$235,800
Total Variable Cost$154,800$247,680$396,288$634,061
Target Profit Margin + Shareholder Return$136,710$218,736$349,978$559,964
Single Product Profitability-$78.57-$12.97$28.03$53.65

This is based on following assumptions –

Assumptions
Growth Factor 160%

Now based on these numbers you can now project what your resourcing would look like –

CurrentYear #1 (Monthly)Year #2 (Monthly)Year #3 (Monthly)
ResourceTotal Fixed CostTotal Variable CostTotal Fixed CostTotal Variable CostTotal Fixed CostTotal Variable CostTotal Fixed CostTotal Variable Cost
CEO$4,000$4,000$4,000$4,000
Finance / Accountant$3,500$3,500$3,500$3,500
IT Developer$8,000$8,000$8,000$8,000
Sales$5,000$8,000$12,800$20,480
Service$4,500$7,200$11,520$18,432
Marketing$3,000$3,000$3,000$3,000
Advertising $3,000 $4,800 $7,680 $12,288
Total Fixed$18,500$18,500$18,500$18,500
Total Variable $12,500 $20,000 $32,000 $51,200
Total$31,000 $38,500 $50,500 $69,700 

This also translates as per below for Tools and Systems

CurrentYear #1 (Monthly)Year #2 (Monthly)Year #3 (Monthly)
Tools and SystemsTotal Fixed CostTotal Variable CostTotal Fixed CostTotal Variable CostTotal Fixed CostTotal Variable CostTotal Fixed CostTotal Variable Cost
Server Costs$400 $640 $1,024 $1,638 
Accounting Softwares$350 $350 $350 $350 
Other softwares$800  $800  $800  $800  
Total Fixed$1,150 $1,150 $1,150 $1,150 
Total Variable $400 $640 $1,024 $1,638
Total$1,550 $1,790 $2,174 $2,788 

And to achieve this, below is your breakdown –

Forecasted Resourcing
ResourceCurrentYear#1Year#2Year#3
CEO1111
Finance / Accountant1111
IT Developer4444
Sales2358
Service2358
Marketing1111
Advertising$3,000 $4,800 $7,680 $12,288 

What’s the difference between SPP and Profit Margin?

Our aim as a growing business should always be to keep re-investing in the business. We want to keep our profit margins to be static so that investors and shareholders have a consistent flow of cash. Also having profit margin fixed gives us an ability to re-invest in the product or offer discounts, without having to cut the profits. This gives us the ability to be price flexible. 

Now, this is where the equation gets interesting. If you think about, SPP is directly correlational to Growth Factor i.e. higher the SPP higher the growth factor and vice-versa. 

But also what this does is, you can choose to sacrifice your SPP in-order to increase your growth factor, which in turn will increase your SPP. Here is an example –

Let’s say your SPP is $10 and your growth factor is 160% for an average $200 product. Now you decide to invest the SPP back into the product i.e. your product is now at $190. Which will automatically make your product cheaper and increase your Growth factor and because your fixed costs are fixed, the net impact on your SPP will only be $5. Or as many businesses find it hard to keep increasing at the rate they were increasing in the first few years, they can decrease the growth factor and still grow the book.

So from our previous example  – 

  
Growth Factor 160%
Current YearYear #1Year #2Year #3
Total Number of products sold (#)1348215734515521
Total Earned ($)$421,400$674,240$1,078,784$1,726,054
Total Fixed Cost$235,800$235,800$235,800$235,800
Total Variable Cost$154,800$247,680$396,288$634,061
Target Profit Margin + Shareholder Return$136,710$218,736 $349,978 $559,964 
Single Product Profitability-$78.57-$12.97$28.03$53.65

Now if you look at Year #2. $28.03. Instead of banking it, if we decide to re-invest in the business, this is what the equation would look like –

AssumptionsFirst 3 YearsNext 3 Years
Growth Factor 160%110%
Current YearYear #1Year #2Year #3Year #4Year #5Year #6
Total Number of products sold (#)1348215734515521607466817349
Total Earned ($)$421,400$674,240$1,078,784$1,726,054$1,726,055$1,726,056$1,726,057
Additional Growth Because of Reinvestment000334196718771525
Additional Growth Because of Reinvestment$0$0$0$104,345$558,934$485,049$358,120
Total Fixed Cost$235,800$235,800$235,800$235,800$235,801$235,802$235,803
Total Variable Cost$154,800$247,680$396,288$672,392$923,322$982,812$1,019,033
Target Profit Margin + Shareholder Return$136,710$218,736$349,978$317,867$405,693$426,515$439,193
Single Product Profitability-$78.57-$12.97$28.03$103.21$89.57$66.13$43.97

This is how SPP can completely change your business.

I completely understand that this can be daunting if you are not savvy with numbers, but I assure you, spend some time with the excel below and see how you can grow your business.

Here is a link to download – 

https://aneeshbond.com/wp-content/uploads/2020/01/Single-Product-Profitability.xlsx

As always I am available for quick chat if you have any questions.