October 24, 2012
Beer is a Profit Velocity industry
“Large selection of hand crafted Ales” says the sign in front of the pub. Who cares? Ever wonder why microbreweries have so many Ales on the menu? Is it to attract the punters? Well, not quite. Lagers, my own preference, dramatically outsell Ales in most of the world despite carrying a 25% price premium on the High Street. Why invest so much production in Ales? “Profit velocity” explains the decision.
In the world’s second oldest industry, or thereabout, whether for home brewers with a large pail in the basement, microbreweries with 3 large tanks or SAB Miller, profit velocity drives the Lager vs. Ale production mix decisions1.
Profit Velocity 101
As a provider of price and margin management solutions, Vendavo spends a lot of time helping our customers to maximize price and margin. Every optimization project starts with an objective: what is the goal? In some cases, margin per unit metrics don’t tell the entire story. Let’s consider the simplified example of my basement brewing operation.
Profit Velocity is effectively a calculation of the cash flow generated by any asset, customer or product or segment over a given time period. The profit per minute, or profit per (machine) hour, or per month generated from a fixed asset, in this case a big bucket taking up space downstairs. Profit velocity is a well understood metric of particular interest to process industry manufacturers, including us beer guys.
Every home brewer is aware of yield: how many of my own concoctions can I drink each week? You don’t have to wait 12 years like a Scotch distillery, but minimizing the time spent waiting for the home brew is an optimization function understood by brewers large and small. Margin per case matters, of course, but producers are really seeking to optimize absolute margin $, in this case, margin $ per year. The yield on Ale is so much larger, and the cash contribution per month so much larger, that it might convince a beer guy to produce and drink Ale, independent of personal taste. And that is what happens. In this simple example, the profit velocity calculation makes the choice clear.
Fig. 1 – A Tale of Two Brews
Profit velocity is not a metric that is useful in evaluating specific customer opportunities, or indeed a metric that can be considered in isolation. Profit Velocity metrics are generally used in a Balanced Scorecard, balanced with pocket margin % to evaluate and assess mix; to identify opportunities to upgrade product and customer mix. A typical process works like this:
- Product managers use Vendavo Profit Analyzer to identify high profit velocity products and the customers and industries that consume those high contribution products.
- Sales then targets customers who buy those high contribution products.
- Product and pricing management adjust pricing targets and floors to help capture high profit velocity opportunities without creating downward pricing pressure. Ideally, sales targets customers who buy higher yield products off the same asset, thereby upgrading customer and product mix.
- ‘High’ contribution is only high in relation to price and margin. Outside of a basement brewing operation, misusing or misinterpreting profit velocity metrics can become a dangerous game: Discounting to capture volume at high margin per hour can lead to self-inflicted pricing pressure. The market doesn’t have visibility into your yield, just into your quoting behavior.
- A Balanced Scorecard is essential. Pioneered by Kaplan, and probably at use in your organization, a balanced scorecard helps to make complementary metrics visible and actionable. Contribution margin % and cash contribution per hour should be considered together, as opposed to in isolation.
Figure 2: Chart Legend
X axis Pocket Margin %
Y axis Profit Velocity, $/hour
Z axis Revenue (Invoice Price $
Each bubble is a product/plant combination
Each color is a production asset/plant
Which product should you make more of?
Employed correctly, profit velocity metrics are a best practice in the process industries. Vendavo makes profit velocity metrics visual and actionable for informing pricing, production and mix decisions, indeed, Figure 2 is easy enough to be consumed by the home brewer.
– Colin Carroll