Sales mix
is defined as the proportion of your total sales that one type of product
represents. If your clothing shop sells $1,000 of red shirts and $2,000 blue
shirts, red shirts represent 1/3rd ($1,000 / $3,000) of your total
sales. The sale mix is 33% red shirts and about 67% blue shirts.
Sales mix is an issue, because nearly all businesses
sell more than one product. Different products may have different levels of
profit. Specifically, think about profit margin, or (profit in
dollars)/ (sales in dollars).
Consider the shirt example. Say you earn a 20% profit
on the red shirts, and a 10% profit on the blue shirts. Your goal is to maximize
total profit. If you shift your sales to the product with the higher profit
margin (red shirts), you’ll earn more total profit.
Farming is a great business to illustrate sales mix. A
farmer has a big decision to make: how much of my available land do I use for
each available crop? A farm can produce different products with the same land.
Which products will generate the highest total profit for the farm?
An April 2013 Wall Street Journal article,
“Farmers Lose Their Taste For Rice”, explains why some farmers are shifting
away from rice production.
The farmers are in Louisiana, Arkansas and
Mississippi. They can produce corn, soybeans or rice. Here are the factors that
move them away from rice production:
·
Comparatively low prices for rice: Corn and soybean prices have spiked, due to less
crop produced during recent droughts. Rice prices have not increased at the
same rate. According to the article, corn prices have increased 50% due 2008
(about 5 years), while rice prices are flat during that same period.
·
Higher labor and equipment costs: “Rice is more labor-intensive and requires more farm
equipment per acre than corn and soybeans.” That’s because rice must be submerged
in 4 to 6 inches of water for most of it’s growing season. So, a farmer must
build levies around each section of the field. The fields must be irrigated to
maintain the correct water level.
Consider the work involved to switch production to
corn or soybeans. You’d have to remove all the levies and level the fields. The
change in production from one product to another is a setup cost. Whether you’re
building levies and planning irrigation (or removing levies), you’re incurring
labor cost and using machines- and incurring more cost.
·
Risk of poor product quality: The article explained a low quality rice harvest is
harder to sell than a poor quality corn of soybean crop. So, if a drought or
infestation affects your crop’s quality, you rather have corn or soybeans than
a rice crop.
Given the additional costs and risks of growing rice,
I’d have to have a higher profit margin than corn or soybeans- maybe a lot higher.
If my corn and soybean profit margin was 10%, I might not plant rice unless the
margin was 20%. If the rice production didn’t go as planned (higher labor or
machinery cost, quality problems), I’d probably have a lower profit margin. If
the profit level on rice declined to 12%, I’d still make more than the other
two crops.
The article concludes that low prices, higher costs
and the risk of poor quality are forcing farmers to stop rice production- and
possibly never go back to that product. Using my example, these famers are
willing to accept a 10% profit margin on corn and soybeans- and avoid the
uncertainties of rice production.
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Thanks!
Ken Boyd
St. Louis Test Preparation
(cell) (314) 913-6529
(email) ken@stltest.net
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