One of the challenges all businesses face is how to grow profitably, which is why I’ve put together this guide on product profitability analysis.
There are dozens of factors that contribute to profitability, and it can be difficult to know where to start.
But before we dive in, let’s start with a quick story…
In the 1990s, Corning (Fortune 500 company) was struggling, so their executives did a deep dive on product profitability across the entire business.
Their conclusion was astounding.
Out of 450 products produced in their facility, half produced 96.3% of revenue, while the other 50% yielded only 3.7%.
After they learned this, they made some big time changes.
They eliminated unprofitable products which were barely selling and carrying a ton of overhead. They also decided to cut 800 suppliers…keeping only the 200 suppliers that represented 95% of supplies.
The result? Corning massively transformed profits and had a way more efficient, streamlined business. This move helped catapult Corning’s growth trajectory to where they are today, with sales of $14.1 billion in 2021.
This same scenario is true for virtually every business, regardless of its size. Most are drowning in complexity and leaving money on the table.
I don’t want you to be one of them.
By the end of this post, you’ll have a proven formula that will help you optimize your business – creating more simplicity while transforming your profits.
Product Profitability Analysis: 80/20 and Whale Curves
You’ve likely heard of the 80/20 rule (also known as Pareto’s Principle) but I often find business owners don’t know how to harness its full potential.
The basic idea is that there are inequalities between cause and effect: 80% of the results come from 20% of the effort. But that’s just the surface.
80/20 applies to pretty much everything in business that you can count or measure, and is an incredibly underrated tool. A small number of factors will always be responsible for the majority of results.
80/20 can be applied in a lot of ways, but for this post we’ll focus on the small number of products generating the majority of sales.
The Vital Few And The Trivial Many
In my experience, when you dig under the covers of any business, you find a few things working incredibly well along with a ton of inefficiency and complexity (unprofitable products, customers, suppliers, etc.). By understanding where the greatest results come from, you can allocate your resources more effectively and get phenomenal results.
By focusing on these key areas, you can make significant improvements with relatively little effort.
In practice, the imbalance between cause and effect is often times even greater than 80/20.
Almost no one realizes that 80/20 is fractal, which means it has an endlessly repeating pattern (there is an 80/20 inside each 80/20).
What does this mean?
It’s possible that 95% of your profit is within 5% of your products. Said differently: your top one or two products likely create more profit than all your others combined. I can almost guarantee that only a small portion of your products should be focused on.
Whale Curve
The concept of 80/20 has been proven over and over again in business and is referred to as the “whale curve.”
It can be eye-opening and is another way to show that a small number of products drive a disproportionate amount of profit.
On average, here’s what this means for your product portfolio:
- Top 20%: Profit Makers (contribute between 200%+ of profits)
- Middle 60%: Profit Neutrals
- Bottom 20%: Profit Takers (destroy 50%+ of profits)
On the whale curve, the difference between the highest point of the chart and current company profitability shows unrealized profit potential for the company.
The key takeaway is that if you can fix or remove your “profit takers” (bottom 20% of products), you can increase profits dramatically. You’ll also have a simpler, more efficient business with fewer operational headaches.
Use Case: The Product Profitability Formula that Saved Apple
I want to include another example to really drive this point home…
In the early 1990s, Apple was in trouble. The company was struggling to compete against Windows-based PCs, and its product lineup had become bloated and unfocused.
In a desperate effort to turn things around, Apple rehired Steve Jobs as CEO. Jobs made the bold decision to streamline the product line and focus on just a handful of key products.
Here are just a handful of things he eliminated:
- Cut desktop models from 15 down to just 1
- Reduced total inventory by more than 80%
- Stopped producing printers and other accessories
- Removed distributors and dealers from the equation, starting selling directly to consumers
In total, during 1998 Jobs reduced the number of products Apple offered from 350 to 10.
Put simply, he cut the fat and doubled down on minimalism and simplicity.
“We examined the future product roadmap. Not the products we’re shipping today, the future product line. And what we found was that 30% of them were incredibly good, and about 70% of them were either ‘pretty good’ or things that we didn’t really need to be doing. Businesses we didn’t really need to be in.” (CNBC Interview)
By simplifying the portfolio, he not only saved Apple from bankruptcy but also brought renewed clarity and energy back to the company.
As a result, these moves helped to revive the company’s fortunes. In the years since, Apple has gone on to become one of the most successful tech companies in the world, and its focus on simplification has been widely praised as a key factor in its success.
Today, other companies are following in Apple’s footsteps, streamlining their own product portfolios in an effort to achieve similar results.
Action Step #1: Know Your Numbers
Let’s make this actionable for you and your business. How can you figure out which products are truly critical versus those that are a profit drain?
The first step is to take time reviewing the numbers across your mix of products.
You need to know how much it costs to produce each product, and how much revenue that product generates. Keep in mind the variable and indirect costs that go into each product – like customer service, marketing, and shipping.
To get an accurate picture of your numbers, you need to track all the costs associated with each product, both direct and indirect.
Here are 5 numbers that I recommend you look at:
- CAC by Product
- LCV by Product
- Unit Profit by Product
- Performance by Profit Center
- Recurring Revenue: ARR, MRR and Churn by Product
You’ll want to do a side-by-side comparison of these metrics for your products. Only then can you make informed decisions about what products are profitable and which ones aren’t.
1) CAC by Product
Customer Acquisition Cost (CAC) is a metric that measures how much it costs to acquire a new customer. When conducting a CAC analysis, you want to look at your marketing and sales expenses for each product.
To calculate CAC, use the following formula:
CAC = Total Sales & Marketing Expenses ÷ Number of New Customers
For example, let’s say your total sales and marketing expenses for Product A is $100,000 and you acquired 1,000 new customers. This would give you a CAC of $100.
2) LCV by Product
Lifetime Customer Value (LCV) is a metric that measures the average revenue that a customer spends with your company over the course of their lifetime as a customer. LCV is important because it allows you to see which products are most likely to generate repeat customers.
You can calculate LCV by using the following formula:
LCV = Average Order Value x Average Purchase Frequency x Average Customer Lifetime Value
For example, for Product A – let’s say your average order value is $100, your average purchase frequency is 2 per year, and your average customer lifetime value is 5 years. This would give you an LCV of $1,000 per customer. ($100 x 2 x 5)
3) Unit Profit by Product
Unit profit by product tells you how much profit you’re making on each individual unit of a product. To calculate unit profit, subtract all manufacturing and overhead costs from the selling price.
4) Performance by Profit Center
Performance by profit center will help you understand which areas of your business are most profitable. For example, if you find that your retail store is more profitable than your online store, you may want to focus more of your efforts on driving traffic to your brick-and-mortar location.
5) Recurring Revenue: ARR, MRR and Churn by Product
If you have products or services with recurring revenue, here are a few more metrics you’ll want to review. Keep an eye out for any anomalies you find between products.
- ARR by Product: Annual Recurring Revenue shows shows the money that comes in every year over the life of a subscription
- MRR by Product: Monthly Recurring Revenue shows the money coming in each month
- Churn By Product: Product churn is when a customer cancels their subscription or stops using a product or service
Action Step #2: Take Action and Improve Profitability
After you finish your review, you’ll have uncovered your most and least profitable products.
By now, I’m guessing you’ll see that a small portion of your products are driving a disproportionate amount of your revenues and profits.
It’s time to take action to simplify and focus on your highly productive products. We want to double-down on what’s working, while getting rid of what’s not.
Here’s what to do next:
1) Concentrate on Your Most Profitable Products
We want to allocate more resources to the top 20% of products by moving time and resources away from the unproductive 80%. Give them more attention!
Here are some questions to think about your best products:
- What are they doing right? What is resonating with customers? How can you do more of it?
- How can you replicate this in other products?
- What do these products have in common?
- How can you promote these products more aggressively?
- Is there anything you can do to improve the quality of these products?
2) Eliminate Underperforming Product Lines
You need to have the courage to make some tough decisions.
Think about what makes the most sense to let go of. If you have a product that’s barely selling and losing money, it might be time to cut it from your lineup.
Think about removing products with these characteristics:
- Can’t be delivered at scale (custom/bespoke offerings that are expensive with little payoff)
- Low value for customer
- Low profitability
- Unable to be competitive in the marketplace or obsolete (i.e. declining market share)
While it can be hard to shut down existing products, think about the drain on resources and what it’s costing you. We need to be willing to cut products that aren’t producing.
If you are afraid of upsetting customers by removing underperforming products, keep in mind what Richard Koch (author of The 80/20 Principle) says:
“In 99% of times, delisting marginal products boosts profits while not hurting customer perceptions one iota”
Remember: if we want to maximize our growth and profitability, we need to find the products that are outperforming and go all in.
Conclusion
Through this review, we can quickly figure out which products are most profitable and can make informed decisions about where to focus.
Whatever you do, don’t ignore what the data tells you. The numbers don’t lie. Don’t be afraid to abandon the good in favor of the great.
Let’s double down on what works and cut complexity and inefficiency. I urge you to take this seriously, as this exercise can completely revolutionize your business.
Remember that the majority of the results are almost always caused by just a few things. By following these tips and doing an 80/20 analysis on your product line, you can ensure that your business is as profitable as possible. As a follow-up step, I’d recommend checking out my post on customer profitability analysis.
I hope you found this guide helpful on your journey to profitable growth in your business. If you have any questions, feel free to let me know in the comments.
Good luck!
