Originally Posted: August 2, 2021
Last Updated: March 31, 2023
Paul Sansom, Business Consultant at Vendavo illustrates how you can conduct a margin impact analysis to get critical insights into what’s driving increases or decreases in your profits.
In today’s age, business analysis can best be described as an infuriating struggle that often ends in analysis paralysis. There are a number of micro and macro impacts that can, and often do, correlate with your business’ performance. Analysts are frequently stumped when attempting to separate what matters from what doesn’t. These exercises are searching for one, very elusive thing: causality.
Which brings us to an unfortunate truth in business today: we typically know what happened, but we rarely know why.
How do we better understand the impact on our margins? Margins can often be made up of revenue streams from various sources and determined by a handful of different factors.
Consequently, it can be all but impossible to know at a glance exactly what’s driving increases or decreases in your profits. This is where a margin impact analysis, also called margin bridge analysis, comes in.
What is a Margin Impact Analysis?
Put simply, a margin impact analysis helps you to look at each of these variables and assess which areas are bringing in the most profit. With this information, it becomes exponentially easier to decide where to focus your time, money, and resources. Here we take a closer look at how to conduct a useful margin analysis.
How to Calculate Margin Impact Ratio
Margin impact can be identified by comparing current profit margin to a future state after making a change.
A simplified example could be as follows. If you decide to change price volume mix, here’s how to calculate your margin impact ratio for a cost-based margin impact.
To begin, find your current profit margin. This can be done by subtracting total costs from selling price and dividing by selling price, then multiplying by 100. Next, calculate the new margin by using the same formula with projected costs. Finally, compare the two margins by subtracting the new from the old to determine the impact of cost changes.
Conducting a Margin Impact Analysis: Recognizing and Isolating Variables
Margins are determined by many factors. These range from your prices and products to the location they are sold in. During margin analysis, it’s crucial to isolate each factor – and this is done by keeping the remaining factor the same. For instance, changing the price of the same products sold in the same area lets you identify how much of an impact price and volume has.
Here are the variables you should understand in depth:
Price & Sales Volume
There is no guarantee that selling a higher volume of product will lead to more profit. Once the cost of goods sold is covered, selling more doesn’t typically lead to an increase in sales dollars left over. Selling more products above cost, however, is one of the most straightforward ways to increase margins. Understanding the impact of this price increase comes down to gross profits; by analyzing gross margins quarter over quarter, it’s easier to see how much additional profit has been earned off the back of a price increase.
Volume & Price Effects
The volume effect represents the effect of revenue/margin change due to changes in volume with an assumption of unchanged prices/margins across the comparison periods. The Price Effect has a similar principle, just flipped around: what are the impacts of price changes on sales volumes and other measures.
Cost Effect
Let’s imagine a scenario where product costs decrease, but “overall” costs have increased, and your aggregated cost effect shows a negative margin impact. What could have caused this? Have variable costs changed? Have sales commissions been adjusted? Are rebates or payment terms or freight costs having a greater negative contribution? With a granular breakdown of your costs, you can pinpoint EXACTLY what, where, and when costs are impacting your bottom line, and do what is necessary to mitigate future issues.
Exchange Rate Effect
International companies that sell across borders should be frequently analyzing the impact of currency fluctuations on sales volume and margin and revenue. This is especially true during times of inflation, stagflation, all the other “-ations”, and strong reserve currencies. But decomposing this effect has historically been a complicated endeavor, to say the least. Being able to assess these impacts, broken into different currencies or groups of currencies (in the same analysis), enables more strategic volume re-allocation. Companies can shift volumes to regions to take advantage of those favorable exchange rates and “unlock” new profit centers.
New & Non-Repeat Business Effect
A typical comparison analysis of one time period to another at the customer-product level, will only make sense if there is a purchase for that customer and product in both time periods. This “match” requirement is a gap in that level of analysis, as it will fail to account for both new, lost, and non-repeat business. But putting the focus and accounting for the “unmatched” business will enhance you understanding of and provide actionable insights into your business development, and sales performance, and product/customer behavior, and how they should affect your pricing strategies and sales forecasts.
Volume / Mix Analysis
There is no guarantee that selling higher volumes will lead to more profit. But understanding the relationship between Price and Volume is key to drawing the right conclusions about the performance of your pricing and sales strategies. Again, the volume effect represents the effect of revenue/margin change due to changes in volume with an assumption of unchanged prices/margins across the comparison periods. The goal of Volume / “Mix” analysis is to separate the impact of the Volume Effect and the impact of relative contribution aggregated to relevant business hierarchies, known as the “Mix” Effect. These business hierarchies include the Product Mix, Sales Channel Mix, Customer Mix, and any other relevant dimension that exists in your dataset.
For example, an unplanned purchase of a large quantity of product from a customer would typically contribute positively to the volume effect. But if the price of this product is relatively low when compared to all other products purchased by this customer, the purchase will cause a change in product mix at the customer level and will display a negative impact to the change in revenue or margins.
Mix is typically nothing you can control and is very hard to manage pro-actively (if at all). However, it can increase the transparency on the impact some of your strategic decisions had on the mix and related impact on revenue/margin, e.g., to quantify the impact of a big global account that you acquired (or lost), or the impact on product mix driven by a new plant that you took into operation. Below are examples of various measurable “Mixes” that we seek to understand with margin bridge analysis:
Product Mix
Some products will have higher or lower margins than others. Some that have low margins can still be the most profitable product for a company if they’re sold in high numbers, while some of those with the highest margins will have a relatively small impact on overall profits. A margin impact analysis will help you understand how different product mixes will affect your overall profits. It can also give you valuable information that will help you formulate promotions involving different products to help you maximize profits.
Location Mix
Depending on the size of your company, you might have outlets in different locations. Each location might have a target audience with different needs and different buying behavior, and different sales methods to adapt to different behaviors and other variables. A margin analysis will help you identify how your locations are performing, and which other variables can affect the performance of each location. It will also help you identify which of the locations has the best sales methods that might also be effective in your other locations.
Sales Channel Mix
Any business is likely to have different sales channels that a margin analysis should consider. Even a boutique store might make sales from footfall and online orders. The same store might also attend events and even have a market stall to sell their goods. Regardless, each sales channel is likely to have different costs and other factors that will have an effect on your overall profits. Each channel is likely to have various impacts on your overall profit other than the margin each product is sold at. For example, the cost of renting a market stall might reduce margins, but it could also improve awareness of your products and brand, helping to increase profits overall. With a margin impact analysis, you will get a better understanding of how each channel affects your business.
Other mix effects such as Customer Mix, Sales Group Mix, and Currency Mix all work in similar ways, and have varying degrees of value depending on the customer and industry. But these mixes bely a gap that often exists in most PVM analysis – the ability to easily define your own Mix effect and apply it to your analysis, thus understanding its effect on your margins. If variable exists and is captured at the transaction level (or can be extrapolated and applied to the dataset), then a custom Mix effect can be created. For example, we were recently approached by a wholesale distribution customer with 11 different methods for calculating freight and asked to help them measure the bottom-line impact of each those different calculations. With some minor data work, in a matter of days, by using Vendavo’s Margin Bridge Analyzer we were able to define the custom Mix effect, and quickly ascertain which freight methodology should be used for different customers, product types, and distribution centers, as well as the methods that should be dropped altogether.
Customize and Drill-Down Your Margin Analysis
The real value in these exercises comes from structuring it in different hierarchies for further “drill-downs”. For instance, reviewing product mix will always be beneficial, but its value improves dramatically when you can analyze that mix effect by industry, region, and customer, in any order that you choose. A high-level review starting and ending at the business unit-level will only bring so much value, as the granular impacts of your business strategy will still not be properly understood. Therefore, choosing which dimensions are used in your margin analysis and customizing the hierarchies have enormous benefits.
Summary
The causes of success or failure are multifaceted and often elusive. Businesses frequently know what happened, but rarely know why. Margin impact analysis helps you break down your profits into individual revenue streams to better understand what is driving increases or decreases in profits. This allows you to make more informed decisions about where to direct your resources. In order to do this effectively, ensure you recognize and isolate individual variables that make up margins. By analyzing gross margins, sales volumes, exchange rate, and repeat business effects, you’ll be able to identify where your pricing and sales strategies are performing well and where they need to be adjusted.
Vendavo offers a dedicated solution to analyzing Price, Volume, Mix performance called Vendavo Margin Bridge Analyzer. It is a powerful SaaS analytics solution enabling large B2B enterprises to understand the impacts on revenue and margin of factors like changes in prices, volumes sold, product mix, and other factors. It also gives large B2B organizations the ability to clearly simulate and quantify the lift or benefit of actions or initiatives like pricing on revenue and margin.
Vendavo Margin Bridge Analyzer not only enables Price/Volume/Mix analysis across different time periods like year-over-year, it also analyzes various datasets like plan vs. actuals. What’s more, you can compare analyses across product lines, sales organizations, and business units for greater insight. With critical, actionable insights into exactly what is driving changes to revenues and margins, your organization will be equipped to make more profitable decisions.
Key Takeaways
- Margin impact analysis helps break down profits into individual revenue streams to identify areas of focus
- Isolating individual variables that make up margins is crucial to understanding what is driving increases or decreases in profits
- Analyzing gross margins, sales volumes, exchange rates, and repeat business effects can provide businesses with actionable insights to adjust their pricing and sales strategies
- The relationship between price and volume is key to drawing the right conclusions about the performance of pricing and sales strategies
- By understanding the components of margin impact analysis, businesses can make informed decisions on where to direct their resources, and you can do this with Margin Bridge Analyzer