Strategic Pricing — The Foundation for Profit-driven Pricing Initiatives

Progressive manufacturers are employing solutions that encompass both margin and velocity information to base pricing initiatives on granular profitability information


Profit-per-minute: The Operational Equivalent of Return on Assets (ROA)

For asset-intensive manufacturers maximizing the return on their huge investment in production facilities is critical. While typically reported as a percentage, return on assets (ROA), is time-based. ROA is perhaps the key measure of profitability for shareholders and the major driver of stock price. It is reported for a year or quarter and so is in essence a profit-per-year or per-quarter value. Profit-per-minute is simply ROA at the product (or customer, deal, market, region, plant) level. Using it as an operational metric will thus ensure that the daily, weekly or monthly decisions made by sales, marketing, finance and production will maximize overall company ROA at the end of the fiscal year.

Using Profit-per-minute Helps Make Optimal Profit-driven Decisions

So how would we use profit-per-minute to make key decisions? Consider Figure 2. The vertical axis shows the traditional metric for profitability, margin per unit. The horizontal axis shows production velocity in units per minute. The topographical curves represent equal values of profit per minute. A higher-margin/lower production speed product might generate the same profit per minute as a lower-margin/higher-speed product. A constant profit-per-minute curve will also translate into a specific return on assets (ROA) percentage. For a company's overall ROA target, we can translate this into a profit-per-minute value. The bubbles can represent products, customers, deals, regions or production facilities. We can then evaluate every product, customer, deal, region or production facility based on its profit per minute and how that compares to the company target value and also to target ROA. This approach provides a common metric and vocabulary across an entire company to ensure optimal decisions are made.

Figure 2: Products with Above-Average Margin May Actually Not Meet Corporate ROA Goals (Product C) While Below-Average Margin Ones May Exceed Them (Product D)

Use Profit-per-minute to Establish Strategic Pricing

Let us look at the ways in which a profit-per-minute approach can dramatically improve profitability by suggesting strategic pricing levels. First of all, consider Product C. It has an above-average margin but does not meet the company target profit-per-minute/ROA target goals. By looking at the chart, we can see that it would take a quite large increase in price to increase margin to the point where a significant increase in profit-per-minute/ROA would occur. (The profit-per-minute/ROA curves are just too vertical in this area of the chart.) If the market could bear such an increase, it should be implemented. In fact any possible price increase should be applied because of Product C's under-target profitability. However, if there was no realistic possibility of a price increase, productivity improvements should be investigated because just a small increase in productivity could have quite a dramatic impact on profitability. (A small move to the right horizontally will produce a significant increase in profit-per-minute.)

Now consider Product B. Despite its below-average margin-per-unit, it meets the target profit-per-minute/ROA company goals. If the market can bear it, just a small increase in price could easily make B even more profitable, since the profit-per-minute curves are very horizontal in this area of the chart.

If we now look at Product D, this product has a margin-per-unit equal to the company average but it generates profits very quickly due to its production run-rate. The size of the bubble indicates that the volume for this product is quite a bit lower than that of Products B or C. A small decrease in price could conceivably increase demand for this product and therefore increase the profit it generates over the course of the fiscal year. Looking at margin alone, it is unlikely a price decrease would have been considered for this product because the company would not have wanted to reduce its margin below the company average. However, the profit-per-minute view clearly shows that this is possible while still maintaining a greater-than-average profit per minute for Product D.

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