Over the past year, UK businesses have had to contend with a lot! First, with the uncertainty and new challenges posed by Brexit, and then with the upheaval of national lockdowns and remote working due to the global pandemic. Whether because of Brexit, COVID-19, or some other unforeseen circumstance, your business may have struggled to generate as much revenue as it used to, if so, you need to develop an offer and sales engine that will ensure you are performing at the maximum. Get in touch at [email protected] if you are looking to increase the selling activity and the overall success of your Sales department (alternatively have a look at our ‘Sales’ blog posts). This article will dive a little deeper and look at the sales you do have and help you decide where to focus going forward to ensure you are picking the sales that will offer your business the most revenue.
To continue, we need to be on the same page when we speak of certain things. There are three definitions we must therefore clarify for the purpose of this article: Sales, Margin and Throughput.
We are all familiar with ‘sales’. Sales is the money that is generated for the organisation through selling goods or services to a customer. Usually, sales are measured in pounds (or your local currency). This figure can tell you a lot. There are products/services that we sell for a higher price (value) which are better for generating revenue than those we sell for lower prices. Then, if you multiply that value by the number of products/services (volume) you are delivering you will know how much money you will have generated through sales. So, ‘sales’ is the money that comes into the business (value x volume).
Most of us are also familiar with ‘margin’. We recognise that not all the money that is earned through sales is ours to keep. There are costs associated with delivering a product or service. Costs that are often deducted to determine the margin include: raw material costs, subcontractor costs, transportation costs, packaging costs, warehousing, staffing/resourcing and delivery costs. So, when you take the sales figure and deduct the allocated cost of the product, you are left with a number of pounds which is indicative of the margin. The margin can be calculated by taking the money that comes in to a business and subtracting the money that goes out. But this is where it gets tricky – how much money do you allocate to costs? When it comes to raw materials, it is straightforward. The cost of the raw materials or components used to make the product should be directly allocated, every additional product you make requires additional materials. Similarly, it is easy to allocate subcontractor costs – you know the number of operations that were carried out externally. The same is true for any third-party transport. But when we consider our own operational costs, the lines begin to blur. How much of a person, or a machine’s time should be allocated to each individual product? And, if we do more in a day, does that cost per product decrease? For example, if in an eight hour shift your team managed to pick 100 items on Monday and only 50 on Tuesday, does the allocated cost double on Tuesday? It’s the same cost, just divided by fewer products. The lines are blurred.
We can see how this might lead us into some trouble. If we do assume that the costs of parts decrease when we complete more of them in the same period, this can lead us to run larger batches, chase efficiencies, build stocks, have longer lead-times and be much less responsive to the needs of our customers – which is where our sales come from. If you want to know more about how to increase productivity and improve your offerings to your marketplace get in touch at [email protected].
There is a better measure to determine which sales generate the most revenue for your business: Throughput. Rather than attributing some or all costs to each individual product or service, you should only allocate the Truly Variable Costs – costs that increase for every extra item you produce and deliver. The rest you should consider as your Operating Expense (the cost of staying open). Things that truly increase for each item you deliver are: raw materials, purchased components, subcontracted operations and any third-party costs required to deliver the goods. You could argue that there is also an element of power, gas or electricity required to produce the goods, however, if you analyse it, you will likely find that it is a very stable cost each month, and the variability is so small that it is in the noise and probably shouldn’t be considered. So, if you only deduct the Truly Variable Costs, you will get a slightly different figure to the calculated margin – this figure we label ‘Throughput’. Throughput is the real money generated by each SKU, part or service you deliver. So, Throughput is calculated by the sales value minus the Truly Variable Costs. Once you understand this distinction, you must begin to look at how to use the Throughput measure. The sales measure alone can be performative and therefore misleading. If you have two products/services that sell for £1000 each, they may have vastly different Truly Variable Costs which means they would make vastly different contributions to the organisation.
So, the first thing you need to do is calculate and understand the real Throughput value of all the goods and services you are offering the marketplace, and understand which are better for the business. You might be surprised by what you find; some middle-of-the-road, or even low selling prices can generate a high Throughput due to low Truly Variable Costs – they might turn out to be absolute superstars for your organisation. On the flip side, some of the high-value sales items might not look as attractive as when you were just looking at the sales price…
Next, if there are any surprise products that you had prioritised the sale of previously but do not generate much Throughput – or even better, products that were low on the priority list but are generating loads, make sure these are communicated to your Sales and Marketing team! You want more of these types of sales than any other. If you find yourself designing a strategy to bring your business back from the damaging effects of COVID, Brexit, or a general lack of sales, make sure that the products or services you are promoting in a competitive market are going to give you the highest amount of real money that you can add straight to your Profit and Loss. If you want any help, either analysing or with achieving more sales of these items, get in touch with Goldratt UK.
Once you know which sales will benefit your business most, you have your sales and marketing strategy; Throughput is the priority. When you are in a position where you have increased sales of high-Throughput items, you will then have an increased load and therefore an increased demand on your capacity – ideally to the point where you might be struggling to deliver. The Throughput measure comes into its own again at this point as it can determine which products are better for your capacity. This means you want to prioritise the products with the maximum Throughput, but that require the minimum bottleneck capacity to produce. We use the concept of ‘Throughput per bottleneck hour’ (stay tuned for a future blog post explaining this concept). With that information, you can go back to Sales and Marketing and encourage them to now promote those products. So, Throughput as a measure can help you to understand which sales are best for your organisation, and once you have a large, healthy order book it can help you to make the best decisions about squeezing the most out of your overloaded capacity – before needing to make any increases to operating expense. This means the money you make will be added straight to your company’s bottom line.
Goldratt UK work with organisations to increase their selling activity and selling success – if you want any advice on selecting the right range to generate the most revenue, get in touch at [email protected]. Furthermore, once you have a large order book full of the right sales, you will likely find yourself struggling to deliver everything. Don’t hesitate to reach out to find out how we would manage capacity to ensure on-time, in full delivery every time.
By Phil Snelgrove, Lauren Wiles