Don’t Confuse Profit First with Short-Term Thinking
By Jason Bader
As many of you who've been following my work know, I am a profit-driven advisor. Sales is for vanity, but profit is for sanity. I love to help drive this mentality in the clients, audiences, and readers I serve but I'm seeing a few scenarios that suggest the quest for higher net-profit percentages is leading distributors into a short-term thinking mentality.
The intoxication with seeing that net profit bulge at the end of the month can be very addictive. I love seeing this happen with the clients I serve, but not at the detriment of long-term growth or sustainability. Growth is imperative. I recently presented a webinar where the reasoning for growth was challenged. Why do we always have to grow? Isn’t maintaining a comfortable level of profitable revenue something we should aspire to? My simple answer was you only coast one way.
A few months ago, I was having a discussion with another client about this growth versus profit conundrum. They are currently enjoying a period of substantial growth and require additional investments in personnel, vehicles, technology, and inventory. These investments are causing a dip in the monthly net profit they were enjoying last year. Since his personal compensation is based on monthly net profit, he is concerned about a diminishing paycheck—working harder and getting paid less is something most of us would be hard pressed to sign up for.
As a result of this reduction in income, I am seeing the client fall into some very short-term decision-making patterns. And, he is not alone. The owner of the business has become concerned with the inventory levels on hand. He has a magic number in his head, in dollars, of inventory that his company should be carrying. Unfortunately, this number is based on a sales number from several years ago.
Investments in personnel have been falling off. The company is no longer actively recruiting to fill the personnel pipeline. Delivery vehicles are not being maintained at regular intervals and new ones don’t seem to have the durability of other options in the market. I am seeing a reluctance to invest in training opportunities and there has been little interest in new products or services. Fortunately, there have been some substantial technology investments that will help them long term. Still, you can see how this reluctance to increase operating expenses is creating a perfect storm. Recently, the storm blew in.
Running a thin staff will test the mettle of any organization. Yes, we have great people who will rise to the occasion; but there is ultimately a breaking point. Mistakes compound. Tempers flare. Fingers start pointing. Eventually, stressed out people start pondering the greenness of other pastures. In this case, 20 percent of the staff has left the company in the last 60 days. Some of these were planned or due to benign circumstances, but I believe most were simply sick of the “toxic environment,” as described by a former employee I reached out to.
Adding to some of the discontent, especially in the sales staff, is the lack of inventory in the most critical SKUs. The reluctance to make these investments is forcing them to substitute and source products that carry a significantly smaller margin. When compensation is based on margin, sales commissions drop. Furthering the frustration is the inability to maintain a delivery schedule due to vehicle break downs. Customers are not receiving product when promised and the sales team members are being dragged in to back up the delivery requirements. It is very expensive to allocate selling time to delivery services. As you can imagine, the quicksand is spreading.
As many of you can see, this was a relatively preventable situation. One of the first mistakes here has to do with compensation. Too much of the overall compensation is tied to the monthly net profit. The decision maker, and to some degree the owner, were too focused on this number. Please understand, I am not advocating that you take your eye off the net profit. That can be equally foolish. Once again, we find ourselves looking for that ideal state of balance—net profitable growth.
I was discussing this challenge with my younger brother who owns a successful distribution company. Once you get rid of the familial dead weight, I guess you can really fly high; but I digress. He shared his thoughts about making investments for the long term and revealed the real test of a company is how it manages the investment period. There will always be reductions in the bottom line as infrastructure is built. Ideally, you want to get that return on investment as soon as possible and resume solid net profit returns. If you want to build a sustainable organization, with manageable growth, you must get comfortable with this investment period. That is the cycle of business.
Two critical areas of investment would have prevented the scenario I described above. First, the company should have never taken their eyes off recruiting and retention. People are the life blood of any organization. Since most privately-held distributors tend to promote from within, there must always be a pipeline of new warehouse and customer service staff coming into the building. I often drive clients to hire one extra person than they think they need. This is how we build a bench of promotable team members. Furthering the personnel investment, companies need to be consistent in their training efforts. Whether it is product knowledge, soft skills or technology use, employees need to be trained. If you think it’s expensive to train your people, try not training them and see what that costs you.
The second key investment this company should have made was in their inventory. Investments in inventory cost money. Often, we must rely on a line of credit to finance adequate inventory levels, which is not a bad thing and should never be feared. Think of lines of credit as a lifeline to customer satisfaction. Furthermore, the owner of the company needed to recognize that greater sales requires a greater level of inventory investment. There is a simple alignment tool that determines the right ratio of inventory dollars to sales revenue, commonly referred to as inventory turn, that would have helped the distributor in this situation.
I don’t know how this company will weather the storm. I don’t think they are too far gone, but they are taking on water. The key message here is balance. Seeing net profit grow each month is exciting and occasionally intoxicating, but let’s keep some perspective. Make sure that you are keeping up with internal investments required to meet your new revenue demands. Be patient with your returns and recognize that private company ownership is a marathon, not a sprint. Good luck and know that I am always here to help.
About the Author
Jason Bader is the principal of The Distribution Team. He is a wholistic distribution advisor who is passionate about helping business owners solve challenges, generate wealth and achieve personal goals. He can be reached at (503) 282-2333 or via email at email@example.com. You can find additional resources on his website: www.thedistributionteam.com