Updated: Apr 21
Part one of this series began with an overview of the levers of profitability for your lab and our review of cost of goods sold (COGS), what it costs you to make your products. In that article, our COGS was 45%, but not all COGS are created equal. In this article we will talk about understanding the components of your product mix, its effect on COGS and how you can reduce your risk of declining profits and keep your lab on the track of improving profitability.
Keep in mind, the COGS in part one did not mean each product you made cost 45%, but rather but rather it was the average cost of goods sold for of all the products you made, at the quantity sold of each, for that period. This is called your product mix for the period and it can have significant implications on your profitability month-to-month.
The product mix, the average of all the products made, at the quantity of each, in a given period of time, is a critical concept in understanding your labs profitability. This is because some products cost more to make than others. An exception to this would be if you created your prices based on a cost-plus basis where you took your cost and applied a desired markup percentage. However, even in this scenario, the profitability would still be affected by the product mix once any customer got a discount on any product, at any quantity.
Let’s look at a typical scenario where the gross profit takes a five-point drop, from 54% to 49%, month over month.
While this scenario certainly plays out throughout the year, not all business owners could point to the reason and understand its implication on profitability. In this example, we see sales have gone up, so how did profit go down? Let’s look at the product mix for that period for some additional details
Looking at the product mix table we can see which products we sold more or less of in each period. Now we combine that with our cost data for each product.
By including the cost data, we can see we sold more of products one and two which contributed to greater revenue, however these products had our highest COGS of 60% and 50% respectively. At the same time we sold less of products two and three which had our lowest COGS of 30% and 25% respectively.
In this example, the gross profit went down solely due to the product mix and not the price sold for each product. So, it assumes just the number of units sold per product line had changed, likely due to new customers, marketing or maybe product one was a new product launch. But the same result can happen even at similar quantities sold if a new, highly discounted customer is brought on with high volume. In that example, the COGS, as a percentage of the unit price, goes up, since the sale price is lower on the units they do, but the COGS to make their products, as a dollar amount, remain unchanged. This also assumes there are no economies of scale that come with that new high-volume customer, which seldom exists, or at least nowhere near to the extent of the discount given.
Referring again to our summary, or collapsed, income statement for the two periods below, we can now see why, even though sales have gone up, the profit has gone down. The reason is the sales simply went up in the products that cost us the most to make and went down in those products that cost us the least.
While the conclusion may seem obvious, the implications are perhaps less so. For example, without knowing this is the result of the product mix, it is possible that whatever caused that trend could continue, slowly pushing the business into declining profitability. Increasing COGS, and lowering gross profit, also increases the breakeven for the lab as well, which we will cover in an upcoming article. But in summary, based on $50,000 of fixed expenses per month, the breakeven of the lab changes from $102,729 to $111,468, an 8.5% difference. A slip of just two more points of gross margin, from 49% to 47%, moves the breakeven of the lab up 14% to $117,021 in sales before the lab would see any profit for the month.
For all the damage a slipping product mix can do to a business, an improving product mix, whereby you sell more of the lower COGS products, can create a dramatic reduction in the breakeven point and improvement in the lab’s profitability. Understanding your dental labs COGS and the impact each has on the total revenue is the first step towards ensuring your business does not accidentally, or unknowingly, focus on the wrong products or customers and will put your lab on the path towards ongoing, improved profitability.