 When
I walk around conventions I generally hear conversations
regarding how the business climate is going. I hear a lot of
talk about how sales are up or sales are down. In good
years, there is a bit of chest puffing and general peacock
behavior.
In the down years, there is a whole lot of blame on the
economy and other external forces. What I don’t hear is a
whole lot of discussion about profit or profitability. Sure,
you might hear some comments about dwindling margins; but
when was the last time you heard someone talk about success
in terms of gross margin dollars? Isn’t that what is really
important? If I can draw a correlation to a golf analogy
“drive for show, putt for dough”, aren’t top line sales
really just for show?
At a very young age, working in my family distributorship,
the importance of gross margin dollars was drilled into my
head. We occasionally talked about sales when it came to an
extraordinary order, but the next question out of every
mouth was – how did we do on it? In other words, did we make
any gross margin on it or are we nurturing our charitable
side? I think this awareness of gross margin came from an
open attitude regarding financials and how income worked in
the company. When your team understands how we pay for the
operation of the company, gross margin begins to take on a
whole new meaning. My brother and I spoke about this
recently and he agreed. As the president of the company, he
is the only one allowed to talk about top line sales. It
only becomes relevant when speaking with banking partners,
accountants or legal advisors.
I am currently working with a client on changing the mindset
from top line sales to gross margin dollars. Eventually, we
will drive down to net profit; but for today, we need to
start with the basic concept of gross margin importance.
Part of the process had to begin with the owner. He freely
admits that he falls into the gross sales trap. It’s a big
number. It’s fun to talk about. It just doesn’t do him a
whole lot of good. When you want to change the mindset of
the people that work with you and for you, it is important
to talk the talk.
The transformation with this client began with education.
With the help of the owner, we gathered the team and
discussed how the income statement worked. Although I had a
basic income statement generated, based on actual year end
numbers, we needed to make sure they understood the concept.
When I discuss income statements in any teaching setting, I
typically use the dollar bill trick to get the point across.
For those of you who haven’t seen this done, here is the
quick and dirty: Hold up a dollar and tell the group that we
just sold something for a dollar and we paid the supplier 75
cents for it. Tear off about ¾ of the bill and drop it on
the floor. By the way, if you use a larger denomination, you
will really get their attention. Holding the remaining ¼ of
the bill, you explain that this represents gross margin. At
this point, I ask the group if the owner of the company gets
to put the gross margin in their back pocket at the end of
the month. I usually see a shaking of the heads, but I would
bet that there are a few that might believe this to be true.
Sad but true, many people that work with you and for you
believe that the owner pockets the gross margin dollars
every month. Obviously, this isn’t the case. I then start
asking about the expenses that come out of the gross margin
before it becomes net profit. While they list off some items
(wages, benefits, rent, utilities, etc), I am consistently
ripping off bits of the bill and dropping it on the floor. I
also make comments on each of the expense items and help
them come up with a few they might have overlooked.
Ultimately, you wind up with a very small chunk representing
net profit. This leads to a discussion of the importance of
gross and net profit. This demonstration is a great way to
start changing the mindset.
Once the team understood how the income flowed, we talked
about the income statement of the location. We talked about
how a slight improvement in gross margin would really change
the net profit picture in the company. The next step in
changing the mindset was to create gross profit goals in the
company. We started with the least profitable location and
developed a daily gross margin goal based on the current
expenses for the location. We bumped it up a bit in order to
foster some downstream profitability. By creating a daily
gross margin goal, we provide a constant reminder of what we
want to accomplish. In this case, we came up with a goal and
then created a simple feedback method designed to show the
location how they were doing. Each day, the branch manager
reviews the sales report from the previous day and writes
the gross margin dollar total for the day on a wall calendar
in his office. For those of you beginning to twitch in your
seats, the number has no dollar designation or decimal
points. In order to tie the number in with our goal, the
number is either written in black pen (for gross margin
dollars exceeding the goal) or red pen (for gross margin
dollars below goal). The calendar is visible to the
employees because you have to walk through the manager’s
office to get to the refrigerator. It doesn’t get much
simpler than this.
One of the ways to make sure that we are driving a gross
margin mentality is to insure that the sales compensation
methodology supports our efforts. What are you basing sales
compensation on? If the commission is a percentage of gross
sales dollars, you are going to have a difficult time
changing the mentality. Although many of you have created
compensation plans based on gross margin, there are still a
few hold outs. I often see this in companies where cost is
not shared with the sales team. This type of scheme can also
be found in companies where deviation from established sales
pricing is rare or non-existent. I hate to say it, but both
of these scenarios lead me to believe that there are some
real control issues in the executive team. When you don’t
empower your people to do their job, your potential is
severely retarded.
Story
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When we put an
emphasis on gross margin with our sales team, there may be a
shift in product focus. Hopefully, we will see a greater
interest in higher profit products. Even when a low profit
product is sold, there will be more incentive to round out
the sale with complimentary high margin products. A swift
way to emphasize margin importance to modify sales
compensation. I recently had the opportunity to meet the CEO
of Fastenal, Will Oberton. For those of you unfamiliar with
the company, they are a multi-billion dollar industrial
fastener and supply distributor boasting over 20 percent net
profit before taxes. In the words of my father, that’s some
pretty tall cotton. He was speaking at an event that I was
involved with and I sat in on his presentation. He spoke
about a bold program that he recently instituted with their
sales compensation. Essentially, if a sales order posted
less than 20 percent gross margin, the order was not
eligible for commission. As you can probably imagine, this
caused a huge ruckus in the sales department. Some of his
regional managers were very vocal in their opposition.
Oberton held his ground. He stated, “If the company can’t
make money on the sale, why am I going to pay the sales
person?” The results worked in his favor. By the end of the
year, their overall margins had improved and some one of the
most vocal opponents said that it was the best thing they
had done in years.
A gross margin mentality can also have an effect on your
accounts receivable performance. I was recently discussing
the benefits of moving to a gross margin focus with a
different client of mine. He is in the plywood and shop
supply business. There had been some recent focus on driving
the sheet goods product category in order to boost sales.
This is a high sales dollar, low margin category. In the
past, the perceived performance of the company was tied to
top line sales. He pointed out that this mentality was
really making collections difficult. He explained that a
$2000 sheet goods sale might generate $140 in gross margin
while a $300 sand paper order might generate that same $140
in gross margin. When it came time to collect on that order,
which bill is your customer more likely to pay in a timely
fashion? It sure made a lot of sense to me.
In a recent article, Tips to Improve Gross Margins, I shared
several ways to boost gross margin percentages without
bringing the hammer down on your suppliers. I was recently
reminded of another way to preserve diminishing margins. One
of the regional managers in my family business used to talk
about pricing strategies inside sales people could use when
confronted with a price objection. The natural reaction when
discounting is to think in increments of 5 – such as 5% off
or 10% off. If you are forced into a discount, try to think
in terms of a 3% discount or 7% discount. Those additional 2
or 3 points can really add up at the end of the month.
Once the gross margin mentality has begun to seep into the
daily lexicon of your employees, you can cement the
transformation by using it to measure performance. I am a
huge advocate of metrics using gross margin as a basis. The
first one that comes to mind is the gross margin dollars per
head measurement. Once a manager has established a goal,
staffing decisions become easier. The same regional manager
mentioned earlier had a benchmark of $10,500 gross margin
dollars per head on a monthly basis. If the gross margin
dollars began to trend up, and the per head figure was
rising significantly, he knew that it was time to add a
body. If the gross margin dollars were diminishing, he knew
when it was time to make cuts.
For those of you familiar with my work, you know that I am a
huge advocate of GMROII or gross margin return on inventory
investment. This metric tells us how many gross margin
dollars we expect to earn for every dollar invested in
inventory. By understanding where we achieve the highest
returns, we can alter our sales direction. We can also use
this information to identify lines where changes in pricing
and replenishment should occur. Since gross margin dollars
drive the operation, it is in our best interest to drive the
highest return.
Adopting a gross margin state of mind is not an overnight
task. It will take months of education and reform. Old
habits die hard and you will find yourself falling back on
the top line sales verbiage. Catch yourself and keep driving
to change your own mentality. Open dialogue with your team,
setting short term profit goals and establishing margin
based performance standards will help you make the shift.
Just remember – sales are for show, gross margins are for
dough. Good luck and I am always here to help.
About the
Author:
Jason Bader is the principal of The Distribution Team, a
firm that specializes in helping distributors become more
profitable through strategic planning and operating
efficiencies. The first 20 years of his career were spent
working as a distributor. Today, he is a regular speaker at
industry events and spends most of his time coaching
distribution executives through every day challenges. For
more information,
call (503) 282-2333 or contact him by e-mail at
Jason@Distributionteam.com. Also visit The Distribution
Team’s website at
www.thedistributionteam.com.
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