The goal of a Direct Product Profitability (DPP) project is to:
Improve sales and gross margin by changing: product assortment, article presentation in the store and consumer prices
Reduce costs by changing: process (logistics, store handling) and product characteristics (package size, item size)
Results of a DPP analysis of 5 different products.
Item A is a slow-moving product with high gross margin. Item E is a fast-moving product with low gross margin. Items B, C and D are medium-moving products with average gross margins and different prices.
Using a traditional profitability ratio (gross margin per week) and even gross margin per week per m3 shelf space, the fast moving product E appears to be the most profitable.
Item C is most profitable. Using the DPP model and after assigning direct product costs to these products, item E shows to be a mega looser, the high gross margin product A also shows a net loss, and only the other 3 products appear to deliver a net profit.
DPP analysis had a considerable impact on assortment tactics and pricing strategy.
The Seven Step DPP process
The DPP model is capable of calculating net profitability of individual items of fast moving consumer goods. Working with the DPP model is a seven-step process:
- DPP model fine tuning: the classical DPP model is adapted to specific product characteristics of your industry
- Input of process characteristics: process characteristics of the logistics chain are entered as activity drivers in the DPP model (examples: delivery frequency, productivity ratios)
- Input of general ledger resource costs: resource costs of the central depot, transportation and the store (examples: transportation cost per km, costs per working hour)
- Calculation of activity costs: activity costs are calculated in the DPP model
- Input of product characteristics: all characteristics of individual products are entered as cost drivers
- Calculation of direct product costs: activity costs are allocated to products
- Calculation and presentation of direct product profitability ratios
Suggested project approach
A. Agree on project plan during initial meeting:
- Project scope: which assortment, which pilot stores
- Project organisation, involvement of consultant
- Project timing
- Project budget
B. Execute the seven step DDP approach
C. Suggest improvement plans and calculate cost- and profitability effects in 5 areas:
- Process changes
- Product characteristics
- Pricing structure
- Article presentation in the store
D. Suggest measures to implement improvement plans
E. Final report
Example: resource costs versus activity costs
2% cost reduction. Resource costs are normally well documented and controlled. Because resource costs are continually reported and controlled, there is often no opportunity (<2%) for substantial cost reduction. See the example for transportation resource costs in the next diagram.
20% cost reduction. Activity costs are normally not reported by classical administration systems. To show these costs, a special activity cost driver model is employed. The advantage of analyzing activity costs is the possibility to substantially (>20%) reduce costs by improving the process.
In the transportation example the activity cost reduction possibilities are: improve load factor, reduce delivery frequency, reduce waiting times, etc.
Please contact RetailEconomics
drs Joost van der Laan
J.W. van der Laan Marketing & Logistics BV
Prins Clauslaan 3
3852 DA Ermelo, Netherlands
Chamber of Commerce 320 56641, VAT number NL802737213B01