More products mean more profits - or do they?
After rapid sales in the early years - usually as a result of providing a niche or new product or a redeveloped product to the market - many businesses find growth starts to slow. In response, they often begin offering variations to their initial products or services. In other words, "if we sell more, we will make more".
Typically, as a business expands its product or service list, it moves away from its core business. Indeed, the number of products and services on offer from a business is a great indicator of where the business is in its lifecycle.
In practice, however, it is common for these businesses to struggle to achieve even minor increases in sales from their newly expanded product ranges. Very often, the only results are eroding returns and constricting cash flow.
The 80:20 Rule
What happens is that the Pareto Rule comes into play. This is where 80% of revenue is derived from 20% of product or service lines. The problem is that the other 80% of product lines on offer erode returns to some extent.
The more products that are introduced, the lower the returns they provide. Greater choice of products detracts from the core business, which is often more profitable. Plus, introducing additional products increases cash flow requirements which results in lower margins. Consequently:
· More products to sell means increasing investment in inventory
· Slower turning products increase the days in inventory
· There is a greater chance of inventory waste, i.e. obsolescence
· Higher overheads to support warehousing, manufacture and sale of an extended product line
Getting back to the core
If your business is struggling to grow its bottom line, that is, you are seeing only marginal increases in sales or profits despite the addition of new products to your range, there are a number of actions you can take:
1. Review the returns for each product or product category.
2. For poor returning products, determine if these are "loss leaders" for higher returning products.
3. Encourage your sales team to emphasise the sale of the high returning products.
4. Reduce your inventory investment or delete the low returning product lines that are not loss leaders.
The benefits of getting back to your core
When you get back to your core service or product offering, you will achieve greater returns. Your cash flow will strengthen, which will give you more funds for growth. And, when you come to sell your business, its valuation will be higher as you have both profit and balance sheet efficiencies and less business risk.
The diagram below shows returns as a relationship between variety of products and growth in sales.
Christopher Brown
Associate Principal, Business Advisory
Tel + 61 7 3218 9852
chris.brown@crowehorwath.com.au