The Industrial Supply Magazine article, “Are you really managing gross margin?”, discusses some techniques for managing gross margin such as segmenting suppliers, setting minimum gross margin requirements for product lines, and reviewing pricing abnormalities and deviations among others.
Excerpts of the article authored by Frank E. Hurtte Jr. who has 28 years of distribution industry experience and a lifetime in sales follow.
“Any short conversation with distributors includes the topics of gross margin”
Any short conversation with distributors includes the topics of gross margin: dollars, percentages, thoughts on GM pressure and the issues with competitors who drive gross margin downwards. But very few actively manage the gross margin of their organizations, with actively being the key word.
Most distributors approach managing gross margin as if they can only indirectly affect the value. They understand sales growth as a driver, so they manage sales. They comprehend lower cost of goods sold as a tool, so they push suppliers to give them special deals. Cerebrally, they understand increases in gross margin percentage radically impact profits, but few go further than cheerleading sessions to push their sales teams to increase GM performance.
“Avoid giving away gains from special supplier deals”
It is not uncommon for supply partners to reward distributor activity, performance or other work with some type of pricing advantage. The premise of the idea is simple: the distributor gets an extra discount which creates greater revenue via improved gross margin. But systemic breakdowns within the distributor operation are legendary. One of the well-deserved supply partner criticisms of distributors lies in their inability to control passing the price along to the customer. Extra margins designed to allow the distributor to make more money are simply passed on to the customer. The market price erodes and everybody loses.
This loss of margin building potential is so rampant that many manufacturers have resorted to passing additional gross margin along via end-of-year rebates. The arguments for and against this procedure have been debated for the past decade. But, there are simple steps to avoid the margin giveaway in the first place.
“Review pricing for abnormalities”
Who in your organization is responsible for reviewing pricing abnormalities and deviations? Back before the recession, a lot of distributors assigned someone to review invoices before they were officially entered into the system. Sometimes it was the sales manager, a senior inside sales person or another person with clout in the organization. They reviewed pricing levels for abnormalities; typically prices set too low for the situation. Somewhere between 2008 and today, this activity has largely been discontinued. Now is a good time to re-visit and re-launch the practice.
“Segment your supply partners”
The concept of segmenting customers has been with us for years, but why not segment suppliers? The issue with Barry is a good reason. Further, there are other issues that must be taken into consideration.
If you enjoy an exclusive on any line, there may be excellent opportunities for pushing gross margin forward. If any of these product lines requires spare parts, why would you consider selling them for anything besides list? A review of your customer list may uncover customers who only purchase this product line from you. Looking at the situation objectively, they probably only buy this product from you because they have no choice. Why would you offer special prices?
Another area to explore and manage in the “exclusive line” offering comes via sales to competitive distributors or resellers. Strangely, many distributor managers leave the price level of these sales to their customer service group. Again, I ask you why discount?
“Gross margin improvements impact distribution like no other business.”
A couple of points in margin improvement typically increases the distributor’s bottom line profits before interest and taxes (EBITA) by 50 percent. And, since distributors are typically valued based on a multiple of earnings, that 50 percent increase to the bottom line increases the shareholder equity by a gigantic amount. Let me toss out an example. A distributor with $20 million in sales might produce an EBITA of 4 percent, or $800,000. If the distributor was valued at eight times earnings (number for illustrative purposes but realistic), this places the company’s value at $6.4 million. Increasing gross margin by two points raises the EBITA to 6 percent or $1.2 million. The new value of the same company with $20 million in sales would now be worth $9.6 million. Many times companies with higher EBITAs are valued at a higher multiple of earnings, further illustrating the need to make margin management a priority.
With payback like this, we can only ask the question, is this really possible or just a theoretical tale spun by a consultant? I know it is both practical and possible to do. It requires some special tools (which I don’t sell, so I have no reason to lie), and some processes which best come from pricing experts like David Bauders and his Strategic Pricing Associates. But, I have witnessed the results at dozens of distributors. The results are game changers.
This article originally appeared in the Sept./Oct. 2015 issue of Industrial Supply magazine. Copyright 2015, Direct Business Media., click here to read the complete article.
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