Harvesting the Extra Profits Hiding in Your
Product Mix
How product mix improvement programs can
increase asset-intensive manufacturers cash
contribution by 3+% of revenues
Michael Rothschild, CEO
March 1, 2013
Introduction
It’s no secret that four key factors: price, cost, volume, and productivity largely determine the cash flow,
profit, and return on assets of any manufacturer. However, across a broad swath of manufacturing, a
fifth factor—product mix—has an enormous impact on financial results, an impact that few
manufacturers know how to fully exploit.
From the cutting-edge world of semiconductors, electronic components, and printed circuit boards to
long-established industrial sectors like steel, aluminum, paper, auto parts, chemicals, plastics, textiles,
rubber, and glass—experienced manufacturing executives know that small shifts in product mix can
dramatically alter quarterly results, even when prices, costs, volume, and productivity remain virtually
unchanged. Some companies have even been known to blame ugly quarters on the ‘mix monster’—an
unexpected shift in the product mix that ate up planned profits.
Manufacturers who produce “electronic components” and “industrial parts” which are then assembled
by their customers into final goods often produce well over 1000 distinct product varieties. In these
“Ultra High Product Variety” companies, where the complexity and financial impact of product mix is
greatest, it is shocking but true that virtually no company can precisely measure and control the profit
swings caused by mix shifts. Why? Because traditional measurement methods, arising from
conventional cost accounting systems, are not capable of rigorously isolating and quantifying the cash
and profit impact of mix changes. Consequently, very few companies have a disciplined method for
proactively managing their product portfolios to maximize cash, profit, and return on assets.
Management teams shocked by a surprise attack of the ‘mix monster’ shouldn’t be. After all, as the old
business adage goes, “You can’t manage what you don’t measure.”
Frustrated by their lack of control over quarterly results, several leading global manufacturers have
implemented innovative solutions that allow them to precisely measure and control product mix
profitability. The financial benefits of these efforts vary by company and industry, but documented
results show that a remarkable $50+ million in profit gain is achievable for every $1 billion in revenue (5
points, or better, of revenue).
Contrary to the common belief of managers and executives, increasing cash flow and profit by
proactively managing product mix is not a matter of selling more of the higher margin per unit products.
Instead, it starts with gaining visibility into what truly drives profitability for the business, “profit per time”
®
also known as Profit Velocity . Though used virtually everywhere to guide decision-making, the
traditional metric of “profit per unit” (ton, gallon, piece, wafer, etc.) sends misleading signals to a
company’s sales, marketing and operations personnel. Time-based profit metrics, however, incorporate
the realities of production into product profitability measures. Armed with Profit Velocity metrics, a
manufacturer can pursue mix changes that typically increase operating income by 5+ points of top line
revenue.
“Our strategy is to shift our product mix towards products with a higher profit per minute,
so we can make significant improvements in cash flow and overall profitability.”
—Jim Kutka, Vice President Commercial, U.S. Steel Corporation
To improve mix, a management team must not only be able to define, isolate and measure the amount
of cash and profit generated as a result of a specific mix shift, but management must also employ a
system and process for continuously improving mix by focusing the entire organization on the products
that generate the highest return for shareholders based on Profit Velocity metrics and not rely solely
on margin per unit metrics. This whitepaper provides a foundation for understanding mix management
and details key elements required to measure, control and maximize product mix profitability.
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 2 of 13
Proprietary & Confidential
Defining “Mix Gain”
Product mix is often loosely defined as the relative amount of each product sold in relation to the
overall product portfolio. Mix is often reported as a percentage share of total unit volume or revenue.
When comparing performance across two time periods at the product level, an increase in total cash
can arise from only two potential sources: 1) an increase in unit volume, or 2) an increase in cash per
unit (net price minus cost). If cost is held constant, then total Cash Gain can be driven only by an
increase in price, Price Gain, or an increase in volume, Volume Gain.
Given the massive amount of data thrown off by the thousands of product items in the product portfolio
of an “Ultra High Product Variety” manufacturer, management tracks price changes by monitoring the
average price for a group of similar products in a product family, rather than by attempting to
understand price fluctuations for each individual product item. Using an average price consolidates the
details into an understandable summary for management, but it hides relative volume changes among
products within a product group and makes gains and losses caused by product mix shifts to be
invisible in management reports. In short, by failing to break out the Mix Gain buried inside an average
Price Gain, conventional cost accounting reports do not provide management with an accurate picture
of what is actually driving change in cash and profit.
FIGURE 1.
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 3 of 13
Proprietary & Confidential
Analysis
A few simple examples using single and multi-product companies will show how the problem of
isolating mix gain can be solved.
One-Product Company
For a company with a single product, there is no opportunity to generate more cash from one time
period to the next through product mix changes. The only way a single product company can change
total cash contribution is by changing price and/or changing volume. Assuming the Material Cost of the
product does not change, then:
Price Change x Volume Change = Cash Change
FIGURE 2.
In this example, an incremental $25 in price is multiplied by the volume sold in the current period to
arrive at $27,500 in cash gain due to price. Similarly, the incremental volume of 100 units is multiplied
by the cash contribution per unit during the baseline period (price minus cost equals $200 per unit) to
yield $20,000 in cash gain from incremental volume. The $200 cash contribution per unit figure in the
baseline period is used, since the increase in cash per unit for the extra volume was already accounted
for in the cash gain attributed to price.
FIGURE 3.
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 4 of 13
Proprietary & Confidential
Two-Product Company
Expanding the analysis to two products, this company has the opportunity to generate more cash from
one period to the next through a third option: a shift in product mix. In fact, when a mix change occurs it
can increase total cash contribution without raising any individual product prices or increasing total
volume. In certain cases, individual prices and unit volume could actually decline, if an offsetting mix
gain generates enough extra cash to cause an increase in total cash contribution.
In the following example, the prices for Products A and B were not changed from the Baseline Period to
the Current Period. Therefore, it would be misleading to attribute any incremental cash gain to Price
Gain. Similarly, since the total volume of the two products did not increase, cash gain should not be
attributed to a Volume Gain. Logic allows only one conclusion. The only possible source of the $20,000
in extra cash is a shift in product mix, or Mix Gain.
FIGURE 4.
In this example, the weighted average price of the products sold increased from $540 to $560 even
though the actual product prices of both products remained unchanged. The traditional cost accounting
approach has been to label such a Mix Gain as if it were a Price Gain. By relying on the change in
average prices from one period to the next rather than doing the calculations to analyze the far more
detailed shifts in the mix and actual product prices, traditional cost accounting methods of variance
analysis fail to reveal the profit generating power of product mix management.
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 5 of 13
Proprietary & Confidential
A final example expands the analysis of the two product company with incremental changes to both
product prices and total unit volume. Using traditional variance analysis methods, the total increase in
cash is split between an average price increase for the two products, and a total volume increase. A
complete examination of price, however, reveals that a shift in product mix yields the most significant
contribution to the total cash gain.
FIGURE 5.
By isolating actual price changes at the individual product level, the traditional metric of Price Gain can
be broken down into cash gain from individual product price changes versus cash gain from a shift in
mix. Since price gain is based on changes in specific product prices, $20 per unit for both products,
$22,000 of gain can be attributed to price ($20 x 1100 units = $22,000). Incremental cash from volume
is calculated by multiplying the cash contribution per unit during the Baseline Period by the number of
incremental units in the Current Period ($240/unit x 100 units).
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 6 of 13
Proprietary & Confidential
FIGURE 6.
The $26,000 in Mix Gain arises from two sources. First, there was a shift in 200 units of the original
volume from Product A to Product B, providing a net increase in cash of $20,000 (200 units x
$100/unit).
The second piece of Mix Gain comes from Product B as its cash per unit value of $300 exceeds the
average cash per unit by $60, generating $6,000 more in Mix Gain ($300 - $240 = $60 x 100 = $6,000).
If the incremental volume had been proportionately split between the two products, preserving the
average unit cash value, then the cash from the new units would have been caused purely by Volume
Gain.
Multiple-Product Company: The Real World
In the simple world of a two-product company, management’s inability to isolate, quantify, and manage
Mix Gain is not threatening. As product prices and volumes change, the back of an envelope offers
more than enough space to do the math, quantify the value of Mix Gain, and take appropriate action.
But for “Ultra High Product Variety” companies, the challenge of controlling Mix Gain is huge—but so is
the profit upside. Without sophisticated information tools, even with today’s computing power, the data
management and computational challenge of mastering Mix Gain is overwhelming. For this reason,
most business analysts working inside manufacturing firms have continued to rely upon the traditional
cost accounting approach of aggregating products into product groups, and reporting the impact of a
mix change on average prices for each product group as if it were a Price Gain.
Even if companies can accurately quantify the impact of a product mix shift, that is not enough to
ensure profit improvement. Traditional product profitability measures must also be updated frequently to
enable management to proactively drive mix changes to drive up total profit even when many product
prices are falling. This is where Profit Velocity comes into play. To understand how to achieve a more
profitable mix, an “Ultra High Product Variety” manufacturer needs to know precisely which products,
customers, and markets have the greatest impact on profits. Traditional “margin per unit” analysis
cannot provide the information needed to answer these questions and will, in fact, frustrate profit
improvement efforts by producing misleading reports.
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 7 of 13
Proprietary & Confidential
Margin Myths and the Missing Link: Profit Velocity®
“Ultra High Product Variety” companies with broad product lines have historically generated far less
cash than they are capable of producing. The inability of large companies with very broad product lines
to correctly track and control Mix Gain as an explicit, measured Key Performance Indicator (KPI) plays
a significant role in this problem of inadequate returns on shareholder capital. An ongoing effort to
generate more cash by optimizing the product mix cannot be pursued without crystal clear metrics that
accurately reflect profitability and rigorously quantify Mix Gain. Until recently, however, the information
tools required to measure and control Mix Gain have not been available.
The primary obstacle preventing “Ultra High Product Variety” manufacturers from harvesting far more of
their true profit potential is the widely held belief that product unit margins accurately reflect the relative
profitability of the various products in a product portfolio. The common strategy throughout
manufacturing businesses worldwide is to use margin per unit data to guide product portfolio decisionmaking at all levels of the organization. Underlying this approach is the assumption that ranking
products by margin per unit will ultimately translate into more overall profit. This is a myth—an
incredibly costly myth.
Unit margin in excess of variable cost, contributes the dollars to the pool of funds that drives the
numerator in return on assets (ROA). As we saw earlier, each unit of Product B, whose margin was
higher than that of Product A, contributed more dollars to the profit pool. But does this mean that
Product B also generates a higher ROA than Product A? Not necessarily. What if Product A is
produced twice as fast as Product B on the same production line? Judging products based on margin
per unit data alone assumes that units of each product are equivalent (a ton is a ton) and the primary
difference is their relative margin dollars. In fact, margin per unit ignores a fundamental product attribute
that significantly impacts that product’s dollar value...its production velocity.
This product attribute is the speed at which the product is produced, its unit velocity or flow rate. In the
steel industry, for example, it takes more time on the mill to roll thin gauge steel sheet than thick gauge
sheet. When the mill’s capacity is taken as a whole, the variation in flow rates amongst the various
thicknesses will ultimately determine how much steel and how much cash the mill produces in a given
period of time. The mill itself does not care what gauge it is running at any particular time; it is capable
of producing a wide range of gauges. For this reason, the cost of the mill’s capacity is the same
regardless of what product is being run. The profit difference of the products, from the perspective of
the assets, is the result of both cash per unit and the unit flow rate. Together, these determine the Profit
Velocity of each product, its true dollar value. Unless both margin and velocity are taken together, the
profit analysis will be misleading. This is the core weakness of traditional cost accounting.
FIGURE 7.
Returning to an earlier example, Product A has a margin of $200 per unit versus Product B’s $300 per
unit. Product A’s production velocity flow rate, however, is twice that of Product B. As a result, Product
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 8 of 13
Proprietary & Confidential
A generates cash 33% faster than Product B. For the same amount of capacity, say 100 minutes, the
machinery will create $160,000 of cash running Product A, while creating just $120,000 running Product
B. Despite Product B’s higher margin per unit, it is less profitable when the capabilities of the
manufacturing assets are included in the valuation.
FIGURE 8.
The economic implications of different production speeds is enormous. With respect to Return on
Assets, the higher Profit Velocity products generate more dollars for a given amount of production
capacity and yield a higher ROA. In short, it is the combination of unit margin and unit velocity that
generates the financial results that shareholders demand: Profit Velocity, earnings, and ultimately ROA.
In order to create revenue and profit, manufacturers transform raw materials by use of their fixed assets
into saleable products. It is the economic efficiency of that transformation which determines the
company’s long-term success. The companies that sell and market the products that generate the
highest cash and profit per asset hour will generate the highest earnings, ROA, and ultimately the
highest return for shareholders. To generate higher cash and profit per hour from the product mix, then,
companies must know precisely how to shift their mix toward higher Profit Velocity products.
Using Profit Velocity to Guide a Shift in Product Mix
In the conceptual examples shown earlier, the one and two product companies have few options when
trying to maximize return on assets. But “Ultra High Product Variety” manufacturers have lots of
options—if they know how to make the most of them. While the potential value of each minute of
capacity on a given production line is the same, its actual value depends on the Profit Velocity of the
product being run. Therefore, the total value of the capacity used depends on the blend of products run
and the associated mix of product Profit Velocities. Maximizing the return on assets comes down to
maximizing the combination of capacity utilization and the overall rate of Profit Velocity.
Customers, prices, and volumes will always be the prime drivers in determining the value of the total
mix. But consistently positive changes in the mix will only come about if marketing and sales is able to
rely on a more revealing metric to rank the most to least profitable choices.
Instead of relying solely on margin per unit (dollars per ton, dollars per wafer, etc.) to guide decisions,
dollars per minute of production time—at a critical process step—becomes the key metric in
understanding how to boost total profits.
Implementing a Profit Velocity approach to setting sales priorities reveals previously hidden
opportunities. Hard data from “Ultra High Product Variety” manufacturers, shows that products reported
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 9 of 13
Proprietary & Confidential
by traditional cost accounting systems to have nearly identical unit margins often yield widely different
Profit Velocities—and therefore widely divergent rates of return on assets.
How could this be? Because “margin per unit” actually measures “return on material cost,” while “profit
per time,” or Profit Velocity, measures “return on assets.” In short, the standard practice of
management teams of relying on “margin per unit” to set priorities, when their shareholders want a
higher “return on assets,” amounts to a fundamental disconnect between daily operational practice and
strategic financial goals.
In the following example, a product portfolio of a major chemicals producer illustrates how margin data
can mislead management by obscuring the actual profitability of an entire product line. Standard margin
is plotted on the vertical axis. Each product’s Profit Velocity is used to calculate ROA, which is plotted
on the horizontal axis. Each “bubble” represents an individual product and is scaled in size to represent
the total amount of cash generated by an individual product during the period covered. The results
shown here are typical for “Ultra High Product Variety” manufacturers:
Along the vertical axis, products are narrowly clustered around a particular margin level. This results
from a “unit-cost-plus-target margin” pricing model where management’s primary focus is on controlling
margin. In this case, a 10% margin was the company’s floor pricing for selling into the automotive
segment.
Along the horizontal axis, product profitability is spread across a broad range of ROA values. Like
virtually all “Ultra High Product Variety” manufacturers, this manufacturer had no ability to integrate
margin and production speed data to monitor and control the ROA of the product mix.
If the manufacturer attempts to raise overall profitability by emphasizing the sales of its higher margin
products—far and away the most common approach to boosting profitability—the narrow range of
margins across the product line, not to mention competition, provides few opportunities for significant
gain. Even worse, by following that policy, the manufacturer would typically neglect products with “low
margin” that also have very high ROAs.
FIGURE 9.
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 10 of 13
Proprietary & Confidential
Harvesting the Profit
Following the conventional cost accounting driven approach of trying to raise overall margins by
shifting the mix toward higher margin products often exaggerates conflicts between the sales and
production teams. The highest margin products are often the slowest and most difficult to make.
At the same time, there may be some low margin, high Profit Velocity products that actually
generate high ROA that are neglected. Instead of running into these same unresolvable debates
again and again, management teams should enhance their profit measurement systems to be
able to monitor and control the Profit Velocity generated by each product, each customer, and
each machine, to equip the managers with information to understand how local decisions in each
part of the organization impact the overall production rate of profit per minute, and implement
programs that increase earnings and ROA by shifting the product mix toward a higher overall
average Profit Velocity (and higher ROA).
“Ultra High Product Variety” manufacturers in a variety of industries around the world have found
new ways harvest the benefits of mix gain by proactively managing Profit Velocity:

Aggressively grow volume and market share in products that generate a high Profit Velocity, even if
they generate below average margin per unit (the “Hidden Winner” strategy)

Equip the marketing organization with the ability to measure and adjust the customer order mix in
ways that raise dollars per minute for fixed total volume orders.

Manage production line loading to help raise the average Profit Velocity.

Substitute or eliminate low Profit Velocity products that chew up production capacity but offer
limited market opportunity.

Use Mix Gain as a hard metric to quantify the success of product mix improvement initiatives.
Significant profit improvement awaits companies that learn to use Profit Velocity to manage their
product mix. “Ultra High Product Variety” manufacturers who have implemented such solutions
have documented profit gain of $50+ million per $1 billion in revenue.
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 11 of 13
Proprietary & Confidential
The chart below illustrates the cumulative cash gain for a manufacturer that implemented a Profit
Velocity system to help drive their product mix strategy. The chart highlights the value of isolating,
controlling, and improving product mix by increasing overall Profit Velocity. In this case, more than $75
million of additional cash was generated over the first 12 month period (approximately 4% of revenue).
FIGURE 10.
Executives responsible for profitability at manufacturers with broad product lines, who are truly
committed to gaining tight control over their bottom line results, should explore the implementation of
tools and methods that will allow their organizations to intelligently manage the product mix and tame
the “mix monster.”
Any company with more than a thousand products has plenty of opportunities to alter its product mix in
ways that would significantly raise profits without disrupting the customer base. Identifying such
opportunities and measuring the cash value of those actions is the challenge. Manufacturers, who have
attempted to manage their mix with spreadsheets, or by simply promoting higher margin products,
commonly fail. Simply put, traditional methods do not have what it takes to properly manage the data
and calculations required to manage mix, nor do they provide easy-to-use information tools needed by
the various departments to turn mix management into specific, profit-enhancing action steps.
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 12 of 13
Proprietary & Confidential
Contact:
Based in San Francisco, with offices in key manufacturing
centers worldwide, Profit Velocity Solutions offers PV
Accelerator, a breakthrough in the power and
sophistication of business analysis and planning tools for
manufacturers.
San Francisco
Available only through its global network of consulting firm
alliance partners, PV Accelerator reveals new profit
improvement insights to drive continuous profit
improvement. By supplementing traditional profit-perproduct-unit margin analysis with the previously unavailable
“missing metric” of profit-per-machine-hour, high-productvariety manufacturers can tap previously hidden
opportunities to accelerate cash flow and achieve major
gains in annual profit and ROA.
Chicago
Singapore
One South Dearborn Street
Suite 2100
Chicago, IL 60603
One Raffles Place
Level 24
Singapore 048616
Shanghai
Taiwan
9/F Eco City
1788 Nanjing West Rd
Jing’an District
Shanghai 200040, China
Shin Kong Manhattan Bldg
14F, Section 5, No. 8
Xin Yi Road
110 Taipei, Taiwan
New York
One Market Street
245 Park Avenue
th
th
36 Floor
24 Floor
San Francisco, CA 94105
New York, NY 10167
Tel: 1.415.456.1000
Info@profitvelocitysolutions.com
For more information, contact us at
http://www.profitvelocitysolutions.com.
© 2013 Profit Velocity Solutions
Mix Gain White Paper (WPH-13A02)
Page 13 of 13
Proprietary & Confidential