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All distributors can quickly and easily increase profit rates and cash flow. All that’s needed is to curtail losses from sales that cost more than they produce in gross profit. The challenge is identifying the sales that are cancelling profits already made, and that’s where analytics comes in. In this article, I’ll share how our clients use analytics to curtail the waste and get significant gains in profits and cash-flow.

Where New Profits Come From

There are really three places new profits can come from:

• Increase sales: finding new customers and wrestling them away from their incumbent suppliers; expand into new markets and do the same; sell more to your existing accounts. Most companies have been doing these things for decades, and with diminishing results.
• Increase prices: getting more margin on some of your existing sales flow. Many companies have implemented sophisticated pricing programs, increasing margins, but not always profits. (As I’ll explain below, margin and profits are not the same, and are often not even correlated.)
• Reduce costs or cost rates: reducing costs is the most under-utilized strategy, principally because it can be tricky to get right, and broad cost-reduction programs are frequently both disruptive and ineffective. However, when done right, this is the most productive area a company can exploit for immediate and significant gains.  Here, analytics is key.

The easiest and fastest source of new profits is within the sales you already have. The distribution industry is historically structured to lose money on more than 60% of all sales, and cover the losses through outsized profit rates on the remainder.

A whale curve is the best way to visualize the dynamic that provides distribution profit.

Every distributor has a whale curve, and the take-away is that new profits are already in your sales flow. Curtailing costs on money-losing sales redirects already-made profits away from subsidizing losses and to your bottom line.

But, Can We Really Cut Costs?

The numbers geeks (I’m one of them) argue that you can’t really cut costs because you still have people and expenses to pay, and they don’t go away. This is partly true, but wherever you’re writing checks, they’ll be smaller if you need less of whatever you’re paying for. Also, your team is plenty busy, and reducing workload in certain areas frees up capacity for future sales growth without also growing expenditures. Extra capacity can increase customer satisfaction, and allows “round-to-it” activities that increase sales and your bottom line.

Companies can (and do) change their cost structures, producing significant profit and cash-flow gains, without hurting customer relationships.

You Can’t Rely on Margin

Gross Margin Rate (GM%) is a lousy way to evaluate profit.  Since it doesn’t account for costs in any way, it simply doesn’t provide any measure of profit at all.

In the chart, some customers are profitable (above the green line) at GM% rates from 14% to over 60%, and others are unprofitable from 4% to over 60%. Almost every customer margin rate is more likely a loss than a profit, and no margin rate is more likely to predict a profit. (As the late Jonathan Byrnes said, “More than 40% of your business is unprofitable, by any measure.” I feel Jonathan was an optimist.)

Margins cannot, and should not, be used to evaluate profit value. Instead, we use an operating profit metric called NBC (Net Before Compensation). NBC deducts expenses from gross margin, and is the best performance measure we’ve found.

OK – Cut to the Chase

There are quite a number of analytics-driven strategies distributors are using to combat escalating wage and interest rates, while driving record profits. These are a few of the most productive:

Conversion Rates (Customer Profitability)

In our analytics, we distribute all costs to relevant invoices with targeted exceptions (excluding warehouse costs from direct ships, for instance), and so we know precise costs (and therefore profits) on everything. Because of this, we use one of the most important concepts in profit management – conversion rates.

Your company has a conversion rate you already know — your bottom-line rate. If your NBT (Net Before Taxes) rate id 5%, then your company converts 5% of its revenue into profit. Every one of your customer relationships also has its own conversion rate, and this is a terrific metric to drive action.

The chart highlights three customer relationships with High, marginal and money-losing conversion rates. NBC% is a solid indicator of customer value, and Exp% is the floor for pricing the customer (any margin above the Exp% will make money). This can be a powerful guide for pricing special bids, and can be the core of a very effective growth strategy.

These metrics drive targeted sales programs, and targeted cost-reduction efforts that work. They also facilitate the most powerful and effective segmentation model that exists.

Profit-Value Segmentation

Good segmentation is a force multiplier.  When done right, you can invent initiatives that can be applied to many customers with similar values and efficiencies. People can really understand which customers get premium services and which need work.

The High-Leverage account group (HLA – bottom row) converts revenue to profit at 12.3% (green), or $12.30 for every $100 in sales. This produces more than four times the profit of the company’s overall average.  This is the most productive area for the sales team to work, and will have accounts that produce profit rates that are more than double the segment average!

Meanwhile, accounts in the High-Efficiency group (HEA – top row) drive expenses at only 8.4% (red) of revenue, compared to the company rate of 18.0%. These accounts are ripe for special pricing programs on strategic products that have them buying more.

PV Segmentation also identifies money-losing small accounts (Reg-) for price increases and cost reductions where the risk of losing the accounts is actually beneficial for the business.

Customer Evaluation

Implicit in the whale curve is that even good customers will have a certain number of money-losing invoices. In larger accounts, this can be a very productive area to work for profit gains.  Consolidating shipments, or negotiating the ‘last mile” for smaller customer locations can save money or free up capacity with little risk or effort.

With detail profit analytics, sales teams can identify customers where negotiating/managing shipments and other logistical activities can significantly increase the value of those relationships.

Minimum Order Quantities

The lowest tier of any price plan can be one of the most valuable and productive areas for new profits. All distributors have issues with their price programs that are the embodiment of the “small order problem”.

In the chart, all sales at quantity 2 and 4 lose money, yet quantity 4 is the most common quantity sold (113 picks). Internally, the product generated $160 in total profit on the profitable sales, but lost most of it to the quantity 2 and 4 sales, retaining only $62. This is repeated tens of thousands of times through the year, cancelling hundreds of thousands in profits made on good sales.

Profit Action Plan

We typically gather a number of the most valuable and actionable stats, and quantify the potential benefit of small improvements in each area. A client plan might look like this:

1) reprice the Reg- accounts — add 2.0% margin to the 5,614 small money-losing accounts that are currently losing $2,477,302 (est. $115,168 added to bottom line)

2) focus sales on penetration of the 424 HLA accounts — these accounts produce new profits at 7.2x the rate of your typical accounts.  (est. $100,986 gain for a 2.5% revenue increase)

3) acquire new accounts that are direct competitors of HEA accounts — these companies add revenue, GP and profit faster than they add expenses, and taking them will deprive competitors of the underpinning of their cash flow (est. $152,064 gain for only 10 new accounts (2.0%)

4) set new MOQs (Minimum Order Quantities) for low-opCash (GP) products — reduces losses on small orders (specifically, on items selling for under $7.50 and losing at least 10% which represented $611,998 in losses)

5) evaluate and work value-add opportunities: for instance, sell delivery as a product (mark it up, train staff, pay commissions); analyze costs/profits on value-added services (a $5.00 delivery charge on 83,651 qualifying deliveries = $418,254 gain)

The rather conservative plan would generate $1,153,670 in additional profits for this company, a whopping 30% gain over their current performance. The gains come from diverting just 5% of the more than $20M of money-losing business in their whale curve.

This is the power of using detailed cost and profit analytics to implement action that addresses the staggering amount of money-losing activity integral to every distributor’s business.

It’s money you’ve already earned — why not do something to keep it?