The Chief Operating Officer who wants to increase the company's profit contribution by better managing the margin of each product category needs the help of the CFO. Only together can they properly analyse the contribution of each product.
Our survey in the food sector shows that almost half the number of products does not make a profit for the company,
This kind of insight only emerges when we bring together data from the factory, warehouse, transport, and finance. When operations and finance collaborate, we’re able to make the right analysis. I strongly advocate for more cross-functional collaboration — not just between operations and finance, but also with input from sales, marketing, and other departments. Introducing product portfolio optimisation is a powerful way to break down silos and align the entire organisation.
The result is a structural improvement in EBITDA. The company is also establishing a consistent process for managing its portfolio over the long term. This means discontinuing loss-making products and supporting the needle-movers, the high-margin portfolio items that generate most of the company's revenue. In this way a Belgian biscuit manufacturer achieved an EBITDA improvement of 3%.
Vegetables and weeds
I like to use the metaphor of a gardener who wants a rich harvest. To get there, I weed every day. I follow a clear process. I decide what I want to grow and what not. I remove what doesn’t fit. I add fertiliser where it’s needed. That’s how I approach product portfolio optimisation.
Manufacturing companies should follow the same process. This requires an understanding of which customers and products help the company achieve its strategic goals and which do not. A key parameter is the rule that determines the difference between the two. Or, to use the metaphor, the difference between weeds and vegetables.
It is essential that the company makes this distinction in a broad discussion among all the company's stakeholders. It is also entirely consistent with a process in which top management defines the mission, values, vision and strategic plan. Defining the portfolio and the minimum requirements that products must meet is an integral part of the strategic plan.
Use the margin elephant
In every portfolio there is a small part of the products that contributes significantly to the company's profit. In the diagram, this is the elephant's trunk. It is often 20% of the product portfolio that generates 125% of the profit.
Next comes a substantial proportion of products that contribute a modest 15% to profitability.
Many companies do not realise that there is a tail at the back of the elephant in the graph, with 30% of the portfolio making a loss, dragging down the overall profit. This tail is always larger than the trunk. Solventure's analysis repeatedly demonstrates this.
The way to tackle this problem is to analyse the various subsets in the portfolio analysis. These can be very diverse. Often a company has both own-brand products and products for the private label market. Or there are big differences in price and margin. The difference can also be determined by region.
I suggest implementing an ABC classification according to sales volume and margin. It would then be obvious to focus on the CC subset with low sales volume and low margin
Part of the explanation for this disappointing contribution lies in the increased complexity associated with a wide range of products. This also raises the question of whether costs are correctly allocated to each product. In any case, it is important to check that loss-making products are not being subsidised by highly profitable products.
In many companies, the cost of complexity is hidden in the changeover to produce various products. The cost of this retooling is usually charged to each product based on volume. In this way, products in the AA segment naturally bear most of the cost. But the costs are caused by the number of changeovers in the CC segment. It is precisely here that there are many changeovers for short production runs.
Solventure therefore proposes not to calculate these costs based on the production volume, but to allocate the same changeover costs to each product. In this way you increase awareness of the profitability of the entire portfolio with all stakeholders in the organisation. Everyone then sees how small the high-margin subset in the trunk is, and how much value the subset in the tail is destroying.
Once the analysis is done, the team should set rules for each subset in the portfolio set. First and foremost, this means properly defining each subset. This can be based on value density: the ratio of volume to value. But an organisation can also make this subdivision based on very different considerations like the strategic positioning. Or it can be based on an internal organisational structure or a regional distribution of customers.
Once the subsets are well defined, their contribution can be measured and benchmarked both internally and externally. Solventure suggests linking this analysis to the contribution of each subset to the operating profit. This can be done using the ROCE ratio: return on capital employed. In this way, the link between the portfolio subset and the overall business results is immediately apparent.
The company can then set targets for each subset in the portfolio: volume sales, working capital utilisation, etc. The aim here is to assign responsibility for these targets to specific teams or managers. These must then have an impact on the drivers for these targets. This is where the company must ensure the accountability of the managers in the organisation.
It is also important to define the rules for portfolio management. To use the gardener's metaphor, this involves defining what are the vegetables and what are the weeds. What are the minimum requirements for the products in the segment? For example, a rule might be that a product must have a minimum number of production hours per year (to reduce the number of conversions). Or a minimum margin for each category.
Once these rules are in place, the firm can immediately perform a portfolio analysis of its own offering based on the historical data available. In the example, you can see that the company has set four rules: a minimum percentage of margin, a minimum amount of that margin, a minimum volume and a maximum number of days of inventory. The analysis then shows that there are 108 violations.
The organisation then needs to investigate the root cause of each breach. The root cause analysis should be the basis of a discussion about the actions the company can take to fix the problem. Should the selling price be increased? Can production improve efficiency? Can purchasing lower the price of the raw materials? If nothing works to achieve the minimum target, the final decision is to stop production.
An organisation should not view this as a one-off exercise. It should become a process in which all stakeholders regularly analyse and measure progress. For example, not only do you need to define actions and assign responsibilities, but you also need to check that everything has been implemented and what the impact has been. This can take a long time.
Implementing a price increase, for example, requires many actions, such as communicating with customers, to have an effect.
For Solventure, it is important that the organisation formulates clear objectives and assigns responsibility correctly. It is then very motivating for the managers and employees involved in the organisation to see the effects of their interventions.
For example, regular reporting on profitability progress can motivate a team but also give them an insight into their contribution to the company's bottom line.
Solventure works closely with clients to achieve this. The aim is to improve their portfolios and thus align their business results with increased revenue, improved profitability and better working capital efficiency.
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