Businesses possess numerous products, revenue streams and customers that each contribute in unique ways to a company?s unit economics. Often times, the effects of price, volume and mix are masked or hidden when looking at the company?s overall performance and primary metrics of interest. Therefore, it is essential for management and investors to take a deeper view and perform the necessary analyses to attempt to isolate the impact price, volume and mix have on a company?s set of key performance indicators.
By doing so, companies can develop informed, data-driven answers to questions that will inevitability arise from investors, board members and other key stakeholders. Additionally, with this data at hand, management and companies can make the appropriate strategic decisions and operational shifts.
In this article, I will walk through an illustrative company?s performance over two periods, and provide the tools needed to perform a detailed analysis and bridge on how price, volume and mix effect a company?s performance. This article will help reduce guesswork management and team members have to make in explaining changes in financial performance. It will also help folks avoid from providing the typically unavoidable responses that arise in reviews and board meetings, such as ?I do not know the answer to that at the moment, we?ll note it? or ?let us get back to you on that one?.
Overview of RTD Software
Our illustrative company, RTD Software, has four main subscription software solutions that it sells to customers. Each has a different price point, were introduced at different points in time, and serve a varying number of customers. Thus, we can expect that the contributions from price, volume and mix of each will be different, as highlighted in the high-level overview below for the company?s first fiscal year presented:
The prices shown represent the annual values of the respective software product. The volume represents the number of sales / customers that purchased each software product and the mix is that volume expressed in percentage terms. Finally, the total column represents the revenue in the period shown, which is a function of multiplying price and volume.
Note that this is a very rudimentary example. Most likely, your company or investments will have varying details and tiers of endless categorizations you can dig into. For instance, instead of looking at price, volume and mix across the portfolio of solutions, you can replace solutions with variables such as customer cohorts, revenue type and industry / vertical segmentation.
Now that we have the first fiscal year of performance mapped out for RTD Software by its four software solutions, let?s present the next annual period for comparison purposes and dig into the effects of price, volume and mix:
From a total revenue perspective, the company has done very well in accelerating growth across the total company and each of its solutions. But the total growth alone does not tell the full story of how and why RTD Software got to where it was in fiscal year 2. Therefore, we must dig into the isolated effect of each price, volume and mix to tell the full story.
Breaking Down the Impact of Price
One of the major variables of organic growth for companies (especially those that are mature) are price increases. Price increases can help generate percentage points of sustained scale, as far as the company continues to provide customers with solutions that they are willing to pay for at higher set prices. On the other hand, price deterioration is also important to understand, as it can show how much of a company?s change in performance are attributable to decreases in price.
In order to isolate the impact of price for RTD Software, we should calculate the difference between the price for each software solution from fiscal year 2 and the pricing for each solution in fiscal year 1. Then, we must take the difference and multiply that netted (subtracted) amount by the total volume sold for each software solution in fiscal year 2, our current reference period.
Why are we taking the difference and multiplying it by fiscal year 2 volume for each solution? That is because we are attempting to isolate only the effect of price on a company?s overall change in total revenue. We do this by keeping volume constant at fiscal year 2?s levels.
Here is the detailed view of how price impacted the company?s overall growth from year 1 to year 2:
Here is an alternative view, depicting the impact of price on total growth $ from year 1 to year 2 by each software solution as a bridge:
As we can see, three of the four solutions had an increase in price from year 1 to year 2. Thus, these isolated price increases have a positive impact on the overall growth (to the tune of a combined $57,500). For software solution 4, we can see that given the price decrease, there is a net negative impact resulting from price changes from year 1 to year 2 of ($5,000), resulting in a total combined amount of price impact of $52,500.
This simplistic view isolates the effect of price on RTD Software?s year-over-year growth. Some key nuances worth noting ? one must be sure that the prices used are homogeneous across the customers / volume. If there are different price points across the solutions and volume data points utilized, this analysis would be masked by higher averages. Folks can still use this analysis with an increased level of detail / information available, but they must be certain to apply all of the known unique price points vs. blended averages in this section in order to accurately break down the impact of price on growth.
Breaking Down the Impact of Volume
Another primary element of organic growth for all companies is selling more volume to new and existing customers. Whether the company sells services, widgets, software or any other product, selling more units typically is positively correlated with improvements in growth. Conversely, when a company fails to sell more volume of its products or services, it may expect to face a decline in overall growth when all other variables are held constant.
In the case of RTD Software, we will want to focus on the volume of each software solution sold to customers from fiscal year 1 to fiscal year 2 to determine the impact volume has on overall growth. Similar to the prior section, this is summarized in a table and bridge displayed below:
To start, we want to first try to isolate how much what the implied volume would look like for each product if we kept prices constant from fiscal year 1. We do this by taking the net volume difference from fiscal year 2 and fiscal year 1, and multiplying it by the fiscal year 1 prices for each software solution (shown in the numbered section 1 in the table above).
Then, we want to multiply the total fiscal year 2 volume (in our example, it is 1,275) by the difference of each solution?s fiscal year 1 price and the average selling price of $973.5 (the $973.5 average price is simply derived by dividing the total fiscal year 1 revenue of $973,500 by the total fiscal year 1 volume of 1,000) and also each solution?s net mix differences from fiscal year 2 and fiscal year 1 (simply, fiscal year 2 mix subtracted by fiscal year 1 mix).
These components are highlighted with the numbered section 2 in the table above. By subtracting these values out of what we derived in numbered section 1, we can isolate the impact that volume has on the company?s total growth between fiscal years 1 and 2.
Breaking Down the Impact of Mix
As a company grows, mix shifts can contribute to drastic changes in a company?s overall performance. This is due to the fact that all products, services, revenue types, customers and market segments are not created equal and have different unit economics. Therefore, it is important that we understand the impact of sales mix and how it contributes to a company?s overall growth.
For the mix analysis of RTD Software?s details, we need to lay out a few additional columns and data points to dig into the impact of mix on its year-over-year growth. To start, we should list out the volume and mix for each solution in fiscal year 1, along with the total volume in fiscal year 2 for the company as baseline figures.
Once we have these laid out, we apply the mix from fiscal year 1 for each solution to the total amount of volume sold in fiscal year 2. This provides us a proxy of what volume for each product should have been if mix were held constant from year 1 to year 2.
From there, we calculate the net difference by subtracting the implied volume per solution at fiscal year 1?s mix % per solution and actual fiscal year 2 volume.
Then, we calculate the difference in price for each solution from the actuals in fiscal year 1 (as highlighted in the price section of this article) and the average selling price we calculated in the prior volume section of the article (which was $973.50). We do this because prices per solution vary widely in the case of RTD Software, and it would be prudent to try to normalize this variable with this mechanism.
Finally, multiplying the net difference in volume and the price difference explained here gives us the impact of mix on the company?s growth.
This table and bridge summarize the effects of mix on RTD Software?s performance from year 1 to year 2:
To bring all the components together, here is a summary table and bridge that shows each of the impacts of price, volume and mix on RTD Software?s performance from fiscal year 1 to fiscal year 2:
Concluding Thoughts: Save Future Time Wasted by Digging in Today
By putting in extra work and effort today, you can save a lot of future headache and address questions that will most certainly come up from management team members, board members and investors. Understanding the effects of each key variable we walked through this article can help improve one?s handle of the cumulative performance of a business and its trends. Therefore, make it a necessity and best practice in all of your current and future financial and reporting workflows to isolate the impacts of price, volume and mix on a company?s performance.
Drop me a line at [email protected] if you have any feedback or questions on this article, or if you would like a free copy of the template I used throughout the piece. And as always, please visit www.rtdinsights.com for more details about how you can gain valuable insight into your business.
