P&L Management Part 3: From Gross-to-Net to Marginality

Now that we've covered pre-P&L analysis and price, the next destination in our journey along P&L is Net Sales, and the course to it goes through known as Gross-to-Net (GTN). The landmark items here are discounts, bonuses and other payments, which a company offers to their direct customers, like distributors and retailers, in exchange for their services. Often, GTN system is quite complicated as it is typically built over many years in order to achieve different and sometimes even conflicting company objectives. This makes it not very transparent and difficult to comprehend for both customers and even people within the company. Therefore, setting a system for regular revision and control of GTN gives the company a lever to increase both Sales (via focusing discounts to enhance Sales drivers) and Profit (by eliminating low-value elements of GTN). The approach can be framed into the following 3 steps:

1. Understand a value of each discount, and only pay the minimum required

2. Focus on value-creating discounts and bonuses

3. Embed GTN control into company’s procedures

Having applied this system in its Ukrainian subsidiary, a large international pharmaceutics company managed to cut total GTN from 13% to 6%. This was mainly achieved by substituting 9% unconditional Sell-in discount by conditional performance driven bonuses. Moreover, such a project changed the mindset within the company, moving GTN from an ‘unconditional’ and ‘determined by market’ to a ‘choice’ and ‘resource’ area, which should be managed like all other resources.

Presentation of the three components of Sales increment (vs. previous period or budget) – price, volume and GTN – gives insights into what drives Net Sales in the period of analysis, while its dynamics versus competition allows us to evaluate whether the selected strategy is right.

Marginality (our next short stop in the journey) is an important indicator of business health as margin erosion is a token of the coming problems for a bottom line. Gross margin is driven not only by Price and COGS (specific for each business), but also by forecasting accuracy. Forecasting is a tool of management control, which pushes business to learn about environmental changes before they become a pain. Increasing forecast accuracy not only provides tangible benefits like reduction in inventory levels and write-offs, but also intangible ones like improvement of relationships with production units and suppliers.

In some businesses like generics in Pharmaceuticals, margin erosion is an unavoidable trait of the industry and those companies, which don’t tune each stone to find opportunities in pricing, GTN and COGS optimization, launch excellence and smarter forecasting risk to lose competition and get serious problems.