Updated: Wednesday, May 3rd 2023, 10:56:51 am
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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 is 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 questions 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.
Essentially, it’s the profit you make selling one unit of a product, inclusive of Fixed Costs, Variable Costs, Growth Factors and margin.
Now that’s a lot of jargon for some of you. So, let’s break it down –
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.
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.
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 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.
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.
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 ($).
Jan-19 | Feb-19 | Mar-19 | Apr-19 | May-19 | Jun-19 | Jul-19 | Aug-19 | Sep-19 | Oct-19 | Nov-19 | Dec-19 | Total | |
Total Number of products sold (#) | 100 | 120 | 110 | 113 | 106 | 109 | 114 | 116 | 143 | 152 | 87 | 78 | 1348 |
Total Earned ($) | $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 –
Resource | Resources | Time | Fixed | Variable | Total Fixed Cost | Total Variable Cost |
CEO | 1 | 100% | Yes | – | $4,000 | |
Finance / Accountant | 1 | 100% | Yes | – | $3,500 | |
IT Developer | 4 | 100% | Yes | – | $8,000 | |
Sales | 2 | 100% | – | Yes | $5,000 | |
Service | 2 | 100% | – | Yes | $4,500 | |
Marketing | 1 | 80% | Yes | – | $3,000 | |
Advertising | 1 | 100% | – | 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 Systems | Resources | Time | Fixed | Variable | Total Fixed Cost | Total Variable Cost |
Server Costs | 1 | 100% | Yes | $400 | ||
Accounting Softwares | 1 | 100% | Yes | – | $350 | |
Other softwares | 4 | 100% | Yes | – | $800 | |
Total Fixed | $1,150 | |||||
Total Variable | $400 | |||||
Total | $1,550 |
Its now time to do some calculations –
Per Month | Per 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 Return | 35% | $101.42 |
Single Product Profitability | ($78.57) |
As you would notice from the above example that the SPP is actually negative, which is quite possible and the next tasks for us is to use this figure and forecast how we can improve this. The problem is not SPP, its actually the growth factor. So let’s calculate the growth factor.
Current Growth Factor | 80% |
Now the Growth factor should always be above 101%, to show that business is actually moving forward. In order to make the growth factor increase there are few things that play an important part.
Current Growth Factor | 80% |
Variable to Fixed cost ratio | 0.66 |
As a rule of thumb Variable to Fixed ratio should able be above 1
If your business is in this situation there are two things you can do
Now I recommend you do both, but focus more on the Sell more products.
If I was to do the projection for next two years for this same business, there are things I will put as constant focus purely on numbers –
Current Year | Year #1 | Year #2 | Year #3 | |
Total Number of products sold (#) | 1348 | 2157 | 3451 | 5521 |
Total Earned ($) | $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 –
Current | Year #1 (Monthly) | Year #2 (Monthly) | Year #3 (Monthly) | |||||
Resource | Total Fixed Cost | Total Variable Cost | Total Fixed Cost | Total Variable Cost | Total Fixed Cost | Total Variable Cost | Total Fixed Cost | Total 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
Current | Year #1 (Monthly) | Year #2 (Monthly) | Year #3 (Monthly) | |||||
Tools and Systems | Total Fixed Cost | Total Variable Cost | Total Fixed Cost | Total Variable Cost | Total Fixed Cost | Total Variable Cost | Total Fixed Cost | Total 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 | ||||
Resource | Current | Year#1 | Year#2 | Year#3 |
CEO | 1 | 1 | 1 | 1 |
Finance / Accountant | 1 | 1 | 1 | 1 |
IT Developer | 4 | 4 | 4 | 4 |
Sales | 2 | 3 | 5 | 8 |
Service | 2 | 3 | 5 | 8 |
Marketing | 1 | 1 | 1 | 1 |
Advertising | $3,000 | $4,800 | $7,680 | $12,288 |
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 $5. Or as many businesses find it hard to keep increasing at the rate they were increasing in the first few years, they can decrease the growth factor and still grow the book.
So from our previous example –
Growth Factor | 160% | |||
Current Year | Year #1 | Year #2 | Year #3 | |
Total Number of products sold (#) | 1348 | 2157 | 3451 | 5521 |
Total Earned ($) | $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. $28.03. Instead of banking it, if we decide to re-invest in the business, this is what the equation would look like –
Assumptions | First 3 Years | Next 3 Years | |||||
Growth Factor | 160% | 110% | |||||
Current Year | Year #1 | Year #2 | Year #3 | Year #4 | Year #5 | Year #6 | |
Total Number of products sold (#) | 1348 | 2157 | 3451 | 5521 | 6074 | 6681 | 7349 |
Total Earned ($) | $421,400 | $674,240 | $1,078,784 | $1,726,054 | $1,726,055 | $1,726,056 | $1,726,057 |
Additional Growth Because of Reinvestment | 0 | 0 | 0 | 334 | 1967 | 1877 | 1525 |
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 –
As always I am available for quick chat if you have any questions.