Margin Dollars vs. Margin Percentage
By Jason Bader
Over the last several years, I have been urging distributors to pay attention to the gross margin percentage in their businesses. I have held the torch for relentlessly driving these percentages up because of the constant downward pressure the competitive process brings. Most of my drive has come from the thought that a 1 percent improvement in gross margin percentage generally translates to a 30-35 percent improvement in net profit. This is due to the overwhelmingly low net profit percentage—somewhere between 3-5 percent of sales—most privately held distributors achieve. Given this knowledge, a small bump in the gross margin percentage is a really big deal.
Recently, I was speaking with one of my coaching clients about measurements and margin performance. I am proud to say that he is fully tuned into the margin measurement versus sales revenue boasting when it comes to performance. Trust me, this was no easy feat. As we were nearing the end of the month, the overall gross margin dollars were falling a little short of his goal. The question he posed to me was, “When should I sacrifice margin percentage to achieve margin dollar goals?” After all, how do we pay bills? Is it with margin dollars or margin percentage? His point was well taken. Without the dollars, we don’t break even or put money in our pockets. So, which is more important?
Like any good advisor, I try not to get trapped in absolutes. There are always situational factors to consider. How much of the business is based on quotation versus matrix transactions? How much influence do salespeople have over the pricing of the product? How established is the company in the market space? Are the goals realistic for the current climate? There are a ton of questions to be considered.
Given the nature of this client’s business, I think it was fair to say that they could loosen the reins on the salespeople and let them dive some margin dollars in the door. By being fairly stingy with the margin side, salespeople felt that they would have to shy away from some larger competitive business. I don’t really fault them. Over the last several years, all they heard was “margin, margin, margin” from myself on the management of the company. For those keeping score, I get bonus points for Brady Bunch references; but I digress. The team had become a bit gun shy. It was time for management to let the sales team make some deals.
In this company, a high percentage of the transactions go through at regular matrix pricing. The perception, by the sales folks, is that they have a highly competitive market. In reality, less than 15 percent of sales require invention by a salesperson. This gives the management an opportunity to satisfy both sides, dollars and percentage, to improve performance.
There are several tactics this company can deploy, I feel like its best options lie in the tweaking of the pricing matrix. There are several ways to accomplish this, either with the help of pricing advisory services or with some good old fashion cost loading solutions. The latter requires the company get comfortable with creating a standard cost for salespeople to work from. It requires a well-thought-out strategy that blends product sensitivity with a certain trust factor between sales and management. The former, which is gaining in popularity, enlists the help of organizations who use proprietary algorisms to analyze pricing opportunities. According to those who have gone down the professional pricing path, there is gold to be had in the database.
On the margin dollar side, there are several ways a distributor can drive margin dollars without sacrificing too much on the percentage side. First, the company needs to set a realistic goal. Expecting to see 30 percent gains year-over-year is probably not going to happen. This is especially true for established players in a period of sustained prosperity. A realistic 7-10 percent growth rate is probably a better bet. Taking this goal and breaking it down to daily gross margin dollar goals will help the sales team stay on track. If they have a below par day, they have the ability to recognize it quickly and course correct early. This has been a proven strategy in several companies I have worked with.
Gross Margin Dollars per Ticket
Many companies have no idea what their average gross margin dollar per ticket is. Like the old saying goes, “You can’t manage what you don’t measure.” When asked to guess, many assume that it is far higher than in reality. This poses an interesting opportunity for incentives. I love to see incentives and rewards for the inside sales teams. Unlike the outside folks, they crush though so many tickets in a day with very little recognition or praise. Create a goal that will drive more dollars in the door. Run a contest and see if they can continually raise the bar month-over-month.
In the heat of battle, many order takers lose sight of their ability to drive margin dollars. In fact, this team can create a tremendous impact if they are willing to give a little effort. Too often, I see order takers accept the quantity requested by the customer with little to no discussion. With a little training, and perhaps an attitude adjustment, order takers can learn to round up to the next package size. For example, let’s say that the normal package size for a box of fasteners is 100 units. When the customer asks for a quantity of 85, I would love to see the order taker state that the product comes in a box of 100 and suggest that the customer take the whole box. The whole transaction is easier for both sides. We get to pick and ship a full box and the customer gets to receive and handle a full box. This tactic works a majority of the time.
To be successful, the order taker must have an understanding of the package sizes or have quick access to that information. Make sure that one of the descriptions in the item database contains simple unit of measure information. Box quantity, case quantity, or pallet quantities can help inside salespeople upsell to the next logical quantity.
Lines per Order
This is one of my favorite measurements for inside salespeople. The average lines per order in had goods distribution is between 2.3 – 3.3. It doesn’t seem to matter what’s being sold, this seems to be everyone’s starting point. Most distributors carry a very complimentary product mix. In other words, there are tremendous opportunities to add one more item to every ticket generated. We need to ingrain the notion that letting a ticket go out with just one line item is a customer service failure. The customer is depending on us to make sure they have all the items necessary to complete the application.
Using technology, particularly the complimentary item file, is just one way to help inside salespeople remember to add on items. Many people fail to populate this feature of their software because of the daunting nature of the task. Work smarter. Businesses don’t need to create complimentary relationships for every item they stock. Just focus on the top 10 percent of the items ranked by hits. These are the most popular items and will give the biggest return on effort.
Finding the Balance
Like most things in business, the answer is not black or white. To find the balance between dollars and percentage, try to understand which tactics can serve both goals. On the margin side, learn to fly under the radar. Raise prices where possible and be sensitive to products that see greater scrutiny. On the dollars side, find ways to add more volume with customer service related activities. And much to my chagrin, go ahead and give salespeople the autonomy to take a couple of deals. Besides, you will never have to opportunity to show how great your company is if you never get the order. Good luck.
About the Author
Jason Bader is the managing partner 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 distribution executive. Today, he is a regular speaker at industry events and spends much of his time coaching individual distribution companies. 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.