This is the third article in a three-part series for distributors to improve long-term financial performance. Part one addressed steps to create an appraisal of your firm’s current financial position. Part two tackled profit improvement variables and key mistakes distributors make.
As noted in parts one and two of this series, Al Bates, principal with distribution research group Distribution Performance Project, in an exclusive MDM webcast described how to begin outlining a financial appraisal of your distribution company from a position of profit. He provided a step-by-step review process to examine a company’s cash position, and explained how to recognize repeated mistakes in order to avoid them.
Here, he outlines an action plan for distributors to emerge out of the COVID-19-induced recession in a high-profit position and prepared for the next economic downturn.
Start with Payroll
Accounting for two-thirds of the expenses of a typical distributor, Bates recommends distributors start by examining your company’s payroll. Payroll as a percent of sales is going up, despite the fact that distributors have made investments in productivity improvement programs, Bates notes. “We’ve been working our buns off to be more productive and we’ve driven up sales per employee,” he says.
Still, payroll as a percent of sales across approximately 20 different lines of trade between 2010 and 2019, on average has gone from about 15% in 2010 to 17% by 2019, Bates’s research finds. (See chart on p. 7) There are two reasons for this. One, steeply rising healthcare costs, and two, the war for talent that — until COVID-19 mass layoffs and furloughs — was driving up salary requirements.
There are three ways to solve the problem, Bates says. First, find out where you’re spending money. Although every industry is slightly different, typically in distribution payroll breaks out into four categories, he adds:
1) Officers and owners. 2.5% of sales; 16.7% of payroll.
2) Sales force. 5.5% of sales; 36.7% of payroll.
3) Operations. 2% of sales; 13.3% of payroll.
4) All others. 5% of sales; 33.3% of payroll.
Note that sales force payroll is a little bit more than one-third of all payroll. “That’s a big number,” Bates says. It’s particularly important because a distributor can work around a warehouse employee, for example, who is not performing well. But, “if I have somebody on the sales force who is a doofus, he’s killing me every single day,” he says.
With that in mind, Bates recommends critically examining the performance level of everyone in the sales field. The worldwide problem that must be acknowledged is that businesses of all kinds need more sales people than there are available people with selling skills. Bates calls selling “a crucially difficult job” that most people cannot do. Even so, people who are not producing need to be replaced, he says. Most distributors will argue that replacing a person costs a lot of money. However, Bates notes that finding a replacement is a one-time cost, whereas failing to meet sales volume potential is a continuing cost.
Know Your Order Economics
Second, and also related to the sales force, is the need to examine order economics. “The battle for sales without payroll expense,” Bates calls it.
There are two areas that are critical to order economics. First, Bates says, is the need to put more lines on every order. Distributors benefit from a rise in add-on selling. In his travers with distribution salespeople, Bates has seen firsthand will-call counters that are not as full as they could have been. “We can do a heck of a lot more add-on selling, product line expansion,” he says. “We ought to have one-stop shopping and then provide customer education; we need to make sure every customer knows what we have.”
Second — and more important — is to raise the average order line. “Crucial” options to do this include selective price increases or changing the order cycle so that customers order a little bit more but less frequently, Bates says. Then, track the results. Efforts that can’t be measured, can’t improve, he adds.
The Reality of Customer Profitability
Third is the value of customer relationships. Bates puts customers into four categories.
1) High-profit customers; 15% of customers; 100% of profit.
2) Good-profit customers; 15% of customers; 35% of profit.
3) Some-profit customers; 35% of customers; 10% of profit.
4) Unprofitable customers; 35% of customers; -45% of profit.
“We need to rethink those relationships with those unprofitable customers,” Bates says.
While many would suggest firing the unprofitable customers, Bates argues against that theory, suggesting instead that distributors begin to work with them.
“There’s very few you should fire, but you ought to start raising their prices systematically and maybe let them fire themselves, if you will, or maybe they will become more probable,” he says. “Work with them, get them to change their buying patterns.”
On his website, distperf.com, Bates provides a what-if analysis for distributors to play with pricing scenarios, i.e., what if price goes down? What if volume goes down? What if we delay our payments to our suppliers?
Bates refers to the exercise as profit-first planning, and sees it as the way for distributors to avoid facing the same issues they may be facing today when the next recession hits.
The Conceptual Planning Process
Profit-first planning, according to Bates, means the first thing a distributor does each year is figure out how much profit they are going to make. He acknowledges many people say it cannot be done that way, but Bates is adamant that it can.
For those who argue that you’ve got to know your sales first before you can address profit, Bates’s response is, “If you know your profit, then you can figure out, how much do I have to sell to make that profit? How much margin do I need to make that profit? How much expenses can I have to have to make that profit?”
To recap the key points in Bates’s profit-driving in an economic downturn series:
• Know where you are. To know where you are, you have to know your break-even point and your cash position with regard to accounts receivable, what Bates calls the cash-sensitivity ratio.
• Avoid the mistakes of the past, such as price cutting.
• Understand the relationship between profit and cash for accounts receivable.
• End the stop-buying edict.
• Deal with payroll. For a company that wants to be a high-profit distributor, expenses are too big a category to not worry about them, Bates says.
• Get control of the sales force.
• Examine order economics.
• Work with low-profit customers.
These points consist of nearly the same advice Bates has provided during previous recessions, he admits. “The problem is, it’s human nature not to do them,” Bates says.