Let’s say we have three products: high margin and low volume, low margin and high volume, and low margin and fast selling. Which product do you want to sell as an entrepreneur?
Generally, the most common answer is that we should sell the highest margin product. But, from an Return on Investment (ROI) or Return on Capital Employed (ROCE) point of view, the above table has insufficient information. In fact, the 3% margin product can actually make more money in the bank and give you a better ROI than a 30% margin product as show below.
For product A, the entrepreneur first invests Rs.45 on day 1 of month 1 to buy the product and marks up for the necessary expenses and down-stream margins, and finally sells at Rs.100. Once the first sale is done and the cash is realized, you can use that same money to pay back for the COGS and again buy the next unit for the next one month. So, essentially, with the same investment of Rs.45 rotated 12 times and earning Rs.3 each time from the sale, the overall return on investment is Rs.36/Rs.45 (80%). So, you earned 80% return on your Rs.45 investment.
For product B, the net margin is 30% of Rs.150 (Rs.45) but the units sold is almost 12 times slower (only one unit sold in one year). The return here is Rs.45/Rs.65. In reality, the return will be actually lower because the Rs.65 invested would’ve to be paid after 45 days (credit period) to the supplier, and hence there should be an interest cost for the Rs.65 for the remaining 320 days (say about 10.5% for 10.5 months at 12% interest per annum). So, that will be an additional cost of 10.5%*Rs. 65=Rs. 6.825, so the actual return is (Rs.45- Rs.6.825)/Rs.65 = 58.7% (ROI).
For product C, the 10 units were bought in one shot with Rs.450 (investment) and even though 10 units got sold, all the 10 units were sold at the end of one year (say on the 365th day). As the margin is 3%, the earnings are Rs.30 but the investment required is Rs.450 and the capital was rotated only once in a year. So, the ROI is 7%, but in reality the ROI will be much lower as the interest cost of Rs.450 for (10.5% for 10.5 months at 12% annual cost of capital: 10.5% * 450 = 47.25) So, the returns are (Rs.30-Rs.47.25)/Rs.450 = -4% (negative ROI).
As we’ve seen in the above example, it is not the highest volume product that wins or the highest margin product that wins but the fastest selling product is what that wins. This is why the velocity of sale is far more important and commands much more weight and attention than any other factor for a company. A 3% margin product that sells 10 times faster can beat a 10 times higher margin product in the market. Product C is the highest volume product (even if it sells 15 units, the ROI will still be lower), Product B has the highest margin, but Product A wins because it is the fastest selling product. Fastest selling (high velocity) usually means high volume too, but high volume need not mean fastest selling (high velocity).
Hope this is useful. Happy Buying and Selling!
Refer to this related post on ROI for further information.