These days, the typical supermarket’s (in mature/developed Global markets) shelves strain to hold between 30,000 and 50,000 unique products, up from about 15,000 in 1991. Yet roughly a quarter of those products sell less than one unit per month.
Similar product proliferation trends are evident everywhere, from car manufacturing to the food industry. However, as more products are created, per-unit revenues (and associated profitability) can drop: One sports drink maker increased its number of flavors three-fold but saw sales per flavor decline nearly 60 percent due to massive cannibalization.
A differentiated product strategy can pay big dividends if companies have the right analytics in place to truly understand profitability. But many firms struggle to achieve this level of transparency. In the mad global dash to be everywhere, all the time, companies often lack the analytical horsepower to determine which products actually make money, and that can be a huge downdraft on shareholder value (see chart).
Make no mistake: Complexity is here to stay—no one is going back to the Ford Model T era of a universal product—and for good reason. At its core, complexity fosters growth, and that’s part of its seductive power. Making more products attuned to the needs of more customer segments generates growth. Problems can occur, however, when companies lose control of product complexity, which in today’s fast-moving, global, competitive environment has become an all-too-common occurrence.
One proven way leaders can cut through complexity’s knottier issues is to use a six-step product complexity management framework, which systematically establishes a product’s “true profitability.” The framework’s power comes from its intense focus on identifying which products to keep and then improving the profitability of those products. Deeper analyses at the product and component levels enable the organization to identify, evaluate and measure product complexity and the potential for improvement. The framework also examines a company’s sales efforts and ultimately helps companies develop and sustain truly profitable products.
Understand true product profitability :
How can you tell whether your current assortment of products is ideal? You could examine product complexity in technical terms, tracking the number of categories, variants and custom products, for example, or analyze sales margins. But these approaches do not typically reveal a product’s actual direct and indirect costs—they don’t capture all of the costs related to its development, procurement and sale. As a result, companies are discovering too late that they are unwittingly destroying shareholder value.
The product complexity management framework provides a path teams can use to understand all of the direct and indirect costs generated when a product is developed, produced and sold. These include direct labor and materials costs, administrative and sales expenses, rebates, discounts, supplier over-payments, an allocated portion of the company’s cost of capital, and whatever other charges and expenditures the company makes related to the product. This assessment creates a picture of the product’s true profitability and can then help leaders determine a road map for re-configuring both their portfolio as well as individual products (see chart).
One consumer goods company wanted to develop an activity-based costing system, which assigns indirect costs to products more accurately than traditional methods, and used the product profitability approach to calculate its product, channel and customer profitability. Doing so enabled it to map the cost base to the activities performed. With this increased transparency, the company could optimize the profitability of its products and markets on a continuous basis.
Eliminate low-profit contributors :
As leaders try to gain clarity regarding the profitability of their products, the first obvious question concerns the company’s portfolio of offerings: Are there products or product features we should think about cutting that won’t affect growth?
However, reliably answering this question requires the cross-functional teams to perform more detailed analyses that complement their existing profitability assessment. They need to collect additional product and market information to verify each product’s strategic importance and incremental sales contribution. For example, companies might be wise to keep an SKU with low sales if it covers a need otherwise not fulfilled (say, high incremental sales).
This analysis shows a product’s incremental value, enabling companies to determine which products are truly profitable, either as standalone items or parts of a cross-selling strategy; which have sufficient potential for improved profitability; and which are strategically important even if they are not as profitable as desired. For all other products, the team should establish and rigorously implement phase-out plans.
A large European food producer conducted an incremental margin, sales and product rationalization analysis using this approach. The project enabled it to cut its product portfolio by 34 percent, which led to significant reductions in the company’s product changeover costs—those costs associated with switching production from one product to another—as well as in labor, logistics, and sales, general and administrative (SG & A) costs, all without reducing revenues.
Improve true product profitability:
Accenture analysis reveals that most blue-chip companies have about 65 percent of their revenues tied up in their cost of goods sold (COGS). Of that, more than 80 percent is for direct material costs. Clearly, if firms hope to improve a product’s profitability, COGS is where to start. Experience shows that best-practice initiatives can produce 10 percent to 15 percent improvements in a company’s COGS within two to three years. But far from a quick fix, such an effort requires strong senior management support to guarantee the full commitment of experts from R&D, sales and sourcing.
Cross-functional teams can define and evaluate a product’s direct cost structure. They can also identify the sources of complexity, which will help them set priorities when finding and executing improvements using the following techniques :
- Standardization & Modularization : Teams employ these approaches to achieve “good” (that is, profitable) complexity levels in a more cost-effective way, which also requires that they understand the best incremental price points to support these levels of complexity.
- Product re-engineering : Re-engineering enables teams to introduce value engineering and product simplification ideas to cut a product’s cost without compromising quality.
- Supplier relationship & Category management : Involving suppliers can throw new ideas, capabilities and innovations into the mix. Category management can help teams break down functional silos and challenge the status quo in areas such as supplier selection and cost-competitive sourcing.
A global industrial equipment manufacturer used this approach to improve its operating margins. The company established a cross-functional collaboration that involved engineering, sales and category management, and integrated this team into its existing operating model to identify and implement modularization, low-cost country sourcing and value engineering opportunities. As a result, the firm realized a 12 percent COGS savings on addressable spending.
Focus sales efforts on true profit contributors :
In the past, sales organizations focused on margin contribution—the revenue generated by each product sold minus its variable cost—to guide their performance improvement strategies. However, this approach often falls short of delivering expected results because it fails to offer insights into the real profitability of products by leaving out such items as SG&A expenses and financing costs. By striving for greater product profit transparency, firms can begin to change the way they allocate resources and incentives to sales efforts, ensuring that the sales force is focused on the products that are most profitable.
Doing so can be especially effective if organizations align their sales strategy and tactics with their new understanding of product profitability. While they should base their new sales force monitoring and steering mechanisms on a data-driven foundation, they also need to introduce new incentive plans that reinforce the desired sales force behavior.
A global maker of premium automobiles introduced a sales force effectiveness program to boost sales at its dealerships. The approach identified best practices among top-performing dealers and then shared them across the dealer network. Through this joint effort, the automaker sold more than 20,000 additional cars, realized a cost-to-contribution ratio of 1 to 12 and boosted its contribution margin by €254 million. What’s more, it recouped the cost of developing and implementing the program in just eight months.
Develop truly profitable products :
Companies working through a complexity reduction transformation usually focus on reducing today’s complexity. Doing so can help them achieve greater product profitability in their current product portfolios—but only for the short term. If organizations hope to sustain their improvements, they need to manage tomorrow’s complexity as well. This need is especially relevant now, because most industries are seeing increasingly shorter product life-cycles.
A sustainable complexity management transformation ensures that R&D does not launch new products based on sales insights only but also considers what’s possible from a technological perspective. To that end, R&D must be empowered to challenge sales managers on the need for designing upgrades or adding new products and features. Doing so will require an understanding of the root causes and drivers of complexity and product profitability. Armed with these insights, R&D managers can actively engage in developing the business case for new products, enabling complexity management to become an integral part of the decision gates1 in the product development process.
The ability to manage complexity effectively also plays an important role in the later stages of product development. R&D often increases product complexity because engineers may find it easier (and personally preferable) to create new designs rather than expand existing product platforms, modules and designs.
To combat tomorrow’s complexity, companies can apply a number of effective techniques, including platform-based product development, component commonality, modularization and design-for-assembly. By focusing more intently on reducing non-value-added product complexity within R&D, companies can often reduce development times, investments and unit costs. They also typically gain scale and efficiency and reduce their time-to-market results.
Some industries are already taking the lead in this area. After decades of rampant product proliferation in the automotive and industrial equipment industries, for example, current trends suggest manufacturers are consolidating their product platforms by as much as 30 percent. This will likely triple expected per-platform product production by 2020 and have a positive impact on both COGS and SG&A (through reduced engineering time).
Consider one global automotive company that wanted to increase its product development efficiency. To that end, it defined and implemented a new product development operating model that included a set of principles to ensure a focus on complexity management. With the new process, the company was able to deliver more products for less R&D investment: It cut R&D costs by approximately 30 percent while increasing new product output by about 10 percent.
Sustain true product profitability :
Determining a company’s true product profitability and the role complexity plays can be an intense and exhausting exercise in itself. Unfortunately, after doing all that hard work, too many companies fail to complete the circle, overlooking the need to weave all that they’ve learned together via a cross-functional governance model into their everyday ways of working. The irony is that this is usually the easiest part of a product complexity management transformation.
To do this, companies need to create a complexity governance model that has FOUR elements :
- Decision-making forums : Organizations need to establish a cross-functional decision-making structure to address product complexity management. The forums can help companies ensure that these decisions happen at the right levels within the organization, and for that reason, they need to involve R&D, sales and sourcing. Companies can achieve this level of cross-functionality in numerous ways—by making it part of R&D decision gate meetings, for example. Other possible venues include a product category management council, product portfolio meetings, or market and brand strategy meetings.
- Roles and responsibilities : To make key complexity-related decisions, companies need to assign capable people to the right roles with the appropriate mandates and responsibilities. Given today’s fast-moving business environment, firms should consider assigning a “complexity manager” responsible for coordinating the entire product complexity management process and ensuring that the costs and impact of complexity are appropriately managed. This should be a central role with a mandate to manage the portfolio and weed out complexity while balancing top-down complexity management against a bottom-up approach that focuses on individual product complexity analysis in the product development, sales, sourcing and product maintenance functions.
- Ways of working : The governance model should also integrate product complexity management as a repeatable process in the regular work routines of R&D, sales and sourcing. Leaders can accomplish this by introducing complexity assessment forms and checklists that teams can use to evaluate and score a product’s impact on complexity throughout its lifecycle. Companies can provide incentives that emphasize complexity drivers and product costs to teams.
- KPIs and monitoring : Finally, organizations should introduce a set of key performance indicators to track product portfolio complexity and ensure that it becomes visible in both upstream and downstream functions. These KPIs should be able to measure complexity on both the demand and supply sides of the business, and pinpoint specific complexity drivers. Leaders in product complexity management often develop a complexity dashboard that enables top managers to make decisions that involve complexity on a continuous basis.
One consumer goods company decided to pursue the full complexity management journey, starting with understanding true product profitability and continuing through sustaining results over the long term. To maintain the positive effects and avoid having complexity reappear, the company tightly incorporated complexity management into its governance model.
For instance, it introduced a complexity management process in day-to-day work practices, formed cross-functional decision forums that made periodic strategic and tactical complexity reviews, and defined appropriate KPIs. Within a year, the initiative had significantly reduced the company’s complexity costs and played a major role in enabling it to introduce better products to market quicker, improving the firm’s competitive position.
” Leaders will find it hard to tame complexity using conventional product portfolio optimization techniques because it requires a holistic, cross-functional approach. They need to cultivate an understanding of true product profitability and ensure their decision-making and governance models reach across R&D, sales and sourcing.
While this is certainly a challenge, the potential rewards are significant. Companies that have focused relentlessly on managing complexity by improving their products’ true profitability have seen savings of 10 percent to 15 percent on their cost of goods sold. What’s more, product complexity improvements will also have a positive residual impact on the rest of a firm’s value chain, strengthening its competitive stance and positioning it for long-term profitable growth “.