Many manufacturers and traders know their total margin but not which products earn it. Shared factory overheads, freight and discounts are spread evenly, so complex products look cheaper to make than they are and simple products carry too much cost.
The result is cross-subsidy: some products are priced too low and others too high, and nobody can see it in the monthly accounts.
Why does gross margin mislead?
- Product lines use machines, labour and changeovers very differently.
- Freight, duties and currency costs differ by market.
- Rebates, bundles and back-end discounts are booked away from the sale they relate to.
- Capacity changes by season, so fixed costs per unit move.
What should we measure?
Agree the views first and keep them stable: product, product line, customer segment, sales channel and market. Changing the definitions every quarter destroys trust in the numbers.
How should costs be built up?
- Direct material at standard, from accurate bills of materials, with yield and scrap.
- Direct labour and machine time by product or by production order.
- Factory overhead allocated on the driver that causes it, such as machine hours, changeovers or batches.
- Cost to serve: freight, duties, packaging, warehousing and sales costs by channel or market.
- Discounts and rebates assigned back to the invoice they relate to.
Which reports matter?
| Report | The question it answers |
|---|---|
| Margin by product line | Which lines earn their place |
| Margin waterfall | Where margin is lost between list price and net margin |
| Customer and channel profitability | Which customers and channels to grow |
| Contribution per machine hour | What to make when capacity is tight |
How do we use the results?
- Reset prices where the real cost is above the price.
- Set discount limits by product line and customer segment.
- Review products that never cover their direct cost.
- Plan capacity around contribution per constrained hour.
Hypothetical example: a manufacturer allocates factory overhead by sales value. When it moves to machine hours, a high-volume, simple product shows a higher margin than reported, and a low-volume custom product moves from a small profit to a loss. Both prices are then reviewed.
Where should you start?
Start with one product line, build the cost model with the operations team, and reconcile it to the general ledger every month. Extend it once the numbers are trusted.