ABSTRACT
Overview A product-based strategy generates growth by identifying new markets in which existing, financially successful products can be sold. Such a strategy should clearly be built on those existing products that have the potential to produce super profits and this makes a system of direct product profitability (DPP) analysis a critical area for marketing finance. The objective of such an analysis is to highlight the relative profitability of
existing products; this normally requires products to be grouped together if the analysis is to be both practical and relevant to strategic decisions. As the classifications of product become more detailed, less costs can be directly attributed to each separate product classification and the DPP analysis becomes less useful in its key decision-support role. The DPP analysis should be tailored to the attributes of the product.
A product with a cost advantage should be subjected to rigorous comparative cost analysis but this is much less relevant where the product attributes are based on differentiation and value-added. Ideally this DPP analysis should be done on a long-term basis over the remaining product life cycle; so that the future potential of the product can be included as well as its current financial performance. There are two very different marketing strategies for product-based strat-
egies where the costs of the product reduce over its life cycle; a quite common phenomenon known as the experience curve. In one case, selling prices today are set based upon the anticipated long-term costs associated with the product; the current loss on sales can be regarded as an investment in attempting to develop a long-term cost advantage. The other pricing strategy seeks to generate profits more quickly, either by setting very high initial selling prices or by reducing selling prices at a significantly slower rate than that at which costs are reducing. These high early profits may attract in new competitors or may delay the development of the market. Many product-based strategies also have the added complexity associated
with trying to sell a range of products to the same customers; there can often be an element of cross subsidisation among the products. Any such discount or rebate granted to a customer should be attributed to the real cause (i.e. its true
cost driver) rather than being apportioned across all the products sold to this customer. All competitive advantages have finite economic lives, and therefore a key
strategic investment decision is whether the company should reinvest part of the super profits being generated from an existing advantage, in trying to develop a replacement competitive advantage. Such reinvestment decisions clearly require rigorous financial evaluation and the risk assessment will be highly influenced by the relevance to the proposed new competitive advantage of the existing core competences of the company. There are many product costing techniques available and marketing finance
should look to apply them more strategically before trying to invent completely new ones. This argument applies to standard costing where the traditional application of variance analysis does not necessarily lead to economically sound decisions. If the method of calculating efficiency/usage variances is modified, it becomes possible to base operational decisions on the most up-to-date cost information available rather than using the standard costs that may well be over a year old. Transfer pricing is another common area of problems for product-based
strategies because, far too often, it is seen as a method of cost apportionment or cost recovery, rather than a genuine pricing mechanism between different parts of the same business. The system should follow the same principles whether the transfer price is for a core process within a vertically integrated group or for the provision of support services. Resource allocation decisions should focus on the use of the critical limiting factor within the business (i.e. the factor that is constraining the future growth of the business) and measure the relative contributions of different products and processes in terms of ‘per unit of the limiting factor’.
