A good measure for evaluation of operational productivity should avoid the two errors—false positives and false negatives. Let us check if the measure of profitability calculated as PBDIT as percent of sales meets the criteria. A growing company, improving profitability IPBDIT as percent of sales (PBDIT%)] over the years is often seen as an improvement in performance.
But can there be a case where decrease in profitability is actually an improvement – a false negative?
To understand this, let us consider a company with two products A and B, with ‘A’ having a gross contribution margin (i.e. throughput or T, defined as sales minus truly variable costs) of 50% and B having a throughput of 10%. Product A has high value per unit volume, while product B has low value per unit volume. So product A is for the ‘classes’, while product B is for the ‘masses’. The company has a very high market share in product A, while in product B it was one of the many players in the fragmented market.
The financials of the company are as below:
Driven by an overall ambitious five-year plan for ensuring a significant growth of the top-line, the company made a business plan of top-line growth target of 50% in the next year. The operating expenses (OE) of the company are planned at absolute value of 16 (a growth of about 7% over last year, mostly led by an increases in the compensation of the employees, as capacities were in place to manage the growth.)
However, the year did not go as planned. As the year progressed, the sales from product A were nearly stagnant, while the overall demand for product A in the market declined. The sales team did a great job in retaining the sales at the same level as in the last year, which means they gained some market share for product A. The compensating growth came from a low-throughput (low T) product B. The sales of product B went beyond all expectations—it doubled!
At the end of the year, the financials of the company is as below: