A Direct Product Profitability (DPP) model is something that every retailer should have in their toolkit. Usually reserved for a particular breed of accountant; ‘the cost accountant’; this tool is vital to assisting with the operational decision making process by giving you the ultimate insight into every single cost that goes into selling an individual product.
I have in the past been that cost accountant and have enjoyed many Board meetings where directors and decision makers are seeing their financial data in a new (and exciting?) way; sparking conversations around the table about the best way to improve the organisation's performance.
If you can assess profitability at the SKU and store level, you are now in an enviable position to be able to improve organisational performance using data rather that perception. Ultimately, a DPP model is designed to:
Improve sales and gross margin by making decisions on product purchase quantities, product mix and pricing strategies.
Reduce costs by making decisions on process (logistics, warehousing and delivery to stores) and product characteristics (package size, item size).
DPP uses various techniques, including Activity Based Costing to assign all direct costs to individual products (not just the cost of goods sold but all relevant overheads) which allows you to calculate the direct profit that is attributable to each individual SKU (this process also works at the product/product group level if so desired). To achieve this, modelling usually incorporates the following steps:
Importing of data from source systems. The main dataset will be a trial balance, but further details are usually required on revenue and purchase data by SKU.
Flagging costs as ‘direct’ or ‘indirect’. Most overheads will be classed as a direct cost, except those more exceptional and one-off costs.
Allocating costs to cost pools. Having decided upon your cost pools (transport, warehouse, store related etc.) each direct cost in the trial balance should be allocated to a cost pool. Where necessary, costs can also be split between two or several pools.
Create cost driver calculations. Each cost pool will have separate and unique cost driver calculations that ultimately allocate the cost pool values to SKUs. For example, the cost pool for store employee costs may be allocated to SKUs based on the volume of sales at each store.
Compare and review the results. Getting the allocations right (or more accurately ‘fair’) may be an iterative process and will involve communication and collaboration between the modeller and managers within the organisation (for example, the warehouse manager should ‘sign off’ on the allocation of warehouse costs as being ‘fair')
Presentation and decisions. Results should be presented to the organisation's decision makers so that any operational changes can be agreed. For example, it may become obvious through modelling that the stock of ‘SKU A’ is delivered to a warehouse in the South East but that 80% of sales take place in the North West, incurring greater than average transportation costs which are affecting margins.
Track progress over time. I would not advocate running this model each month; quarterly or half-yearly is usually sufficient depending upon the amount of change that is taking place in the organisation.
This out of the box accelerator Application gives you the essential building blocks of a top class DPP model –so why not upgrade your toolkit today.