One common challenge faced by many entrepreneurs is starting a business without having a comprehensive understanding of their product or its specific details. A product refers to a new offering introduced by companies into the market, such as innovative oils, soaps, medicines, and more. These companies, known as product companies, aim to provide solutions to customers’ needs and problems through their new products.
Consider the following scenarios:
1. If you work in the medical field and believe that existing cough medicines are not effectively treating coughs, you might decide to develop and launch your own brand of cough syrup.
2. In the personal care industry, you may decide to create a new type of deodorant with unique fragrances, similar to what AXE has done, which has gained significant popularity.
When establishing a product company, you will need to address the following key decisions:
– What specific product should be manufactured?
– What will be the production cost of the product?
– How will the pricing of the product be determined?
– What strategies will be implemented to manage employee expenses?
When a product company operates, it may not directly sell its products, but instead utilizes distributors and retailers for offline sales and e-commerce platforms like Amazon and Flipkart for online sales. In this scenario, it is crucial for the company to determine the margins for the distributors and retailers. Failing to set the right margins can lead to reduced profits and may even cause distributors and retailers to discontinue their partnership with the company.
Moreover, pricing the product correctly is essential for profitability. Setting prices arbitrarily based on competitors’ pricing is not a sustainable strategy. For example, if a similar product is priced at Rs. 100 by a competitor, pricing it at Rs. 99 with the expectation of making a profit may not be feasible.
Understanding the profitability of the business is fundamental for its sustainability and growth. Without a clear understanding of the company’s profitability, it becomes challenging to make informed decisions and chart a path for growth.
Implementing the one-third framework can provide a structured approach to running the business, aiding in decision-making and sustainable growth.
What is One-Third Framework?
The One-Third Framework is a principle that involves dividing your business and revenue into three equal parts.
The first one-third represents the product development cost. For example, if the sales price of a product is Rs. 100, then one-third of this price, which is Rs. 33, should be allocated to the production cost. This production cost includes the cost of raw materials, packaging, labor, and other expenses related to creating the product.
The second one-third is allocated to business operations costs, including salaries, rent, administration, marketing, channel partner expenses, as well as the margins of distributors and retailers.
The third one-third represents the profit before tax. After deducting taxes, the remaining amount is the actual profit from the business.
Following the One-Third Framework can serve as a helpful guideline for managing the finances and operations of a business.
Examples of Companies using One-Third Framework
Bajaj Consumer Care
In the case of Bajaj Consumer Care, the total revenue amounts to Rs. 935 crores, with the product cost being Rs. 237 crores, which translates to 32% of the total revenue. The business cost, encompassing various elements such as depreciation, rent, electricity, interest, marketing, distribution, and employee salaries, totals Rs. 355 crores, constituting 38% of the total revenue. When combined, the product cost and business cost amount to 70% of the total revenue. The profit before tax stands at Rs. 283 crores, representing 30% of the total revenue.
Thyrocare
- Total Revenue: Rs. 403 Crores
- Product Cost: Rs. 109 Crores, accounting for 26.4% of the total revenue.
- Business Cost: Rs. 167 Crores, representing 40% of the total revenue.
- The combined Product Cost and Business Cost amount to 66.4% of the total revenue, which is 2/3rd of the total revenue.
- Profit Before Tax: Rs. 138 Crores, equivalent to 33.4% of the total revenue.
Naukri.com
In the following financial analysis of Naukri.com, we find that the total revenue amounts to Rs. 1271 Crores. The manpower cost is Rs. 520 Crores, representing 40.9% of the total revenue. Additionally, the business cost is Rs. 341 Crores, making up 26.8% of the total revenue. When we sum up the manpower cost and business cost, it accounts for 67.7% of the total revenue, leaving the profit before tax at 32.3%.
It’s worth noting that the companies mentioned are all publicly listed and tend to have profits before tax around 33%. This suggests that if an individual is unable to take one-third of the revenue as their earnings, they should consider adjusting other costs to align with this target.
For product companies, it’s essential to implement a framework where the product cost and business cost constitute two-thirds of the total revenue, while aiming for a profit before tax of one-third. This approach can ensure a balanced and sustainable financial structure.
Merits of One-Third Framework
The One-Third Framework offers several benefits for businesses:
1. Clear Benchmark: This framework provides a clear benchmark that businesses can work towards, ensuring a focused and targeted approach to achieving their goals.
2. Alignment of Owner and Managers: The One-Third Framework ensures that owners and managers are aligned and working towards a common goal, promoting unity of purpose within the organization.
3. Profitability Assurance: By following the One-Third Framework, businesses can ensure profitability, providing a sense of financial security and stability.
4. Positive Cash Reserve: Implementing the One-Third Framework can lead to a positive cash reserve, as the framework emphasizes consistent revenue generation.
5. Track Deviation Awareness: The framework enables businesses to quickly identify any deviation from the One-Third approach, allowing for prompt corrective actions based on specific performance metrics.
6. Revenue Growth and Cost Optimization: The One-Third Framework encourages businesses to focus on either growing their revenue or optimizing costs, with the aim of achieving a positive impact on both the J-curve and the One-Third metric.