News from the Safety Equipment Distributors Association
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July 2007 return to the newsletter contents page All Sales Volume is Not Created Equal by Dr. Albert D. Bates, President, Profit Planning Group |
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Sales solves all problems. Wait, make that
sales solves most problems. Actually, sales solves a lot of problems,
but creates a lot more. The understanding that “nothing happens until
somebody sells something” causes otherwise rational individuals to
undertake some bizarre sales-generating activities. It is enough to give
sales a bad name. |
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Good Sales Versus Bad Sales—A financial review of how sales volume works through the business. Particular attention will be given to how the type of sale influences expenses.
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Targeting Good Sales—A discussion of the inherent difficulties in motivating employees to focus on good sales.
Good Sales Versus Bad Sales
Just as there is good and bad cholesterol, there are good and bad sales,
depending upon the impact that the sale has on expenses. More than
anything else this expense impact is dependent upon whether the firm
generates sales from existing customers and products or new ones.
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Good Sales—This includes any form of sales growth that can be achieved without a commensurate increase in expenses. The most notable examples are inflation which automatically increases sales, greater penetration of existing accounts and raising the firm’s fill rate (even though carrying more inventory may be required).
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Bad Sales—This includes any sales growth that requires a significant expense increase to generate the sales growth. This would include targeting new customers, expansion of the product line by adding more SKUs or product categories and opening new branches.
Exhibit 1 reviews the income statement for a typical SEDA member. It shows the firm in its current state and reviews two very different sales growth scenarios.
In both scenarios sales have increased by
5.0%. This sales growth figure could be the result of any combination of
organic growth, inflation, additional products or branches or any other
activity that generates more sales volume. The exhibit is saying nothing
about the source of the sales growth as of yet.
In both scenarios the gross margin percentage has held constant at 26.0%
of sales. The firm continues to buy and sell items at the same relative
price points as it did before. The result is that both cost of goods
sold and gross margin increase at the same 5.0% rate that sales
increases.
Further, non-payroll expenses have also increased by 5.0% in both
scenarios. This is a correct assumption regarding the long-term trend in
non-payroll expenses. It is tenuous in the short run, but is useful in
illustrating the concept.
The real key in the exhibit is the extent to which payroll (and
associated fringe benefits) has to grow to support the increase in
sales. In Scenario 1, sales have increased by 5.0% while payroll and
fringe benefits have increased by an arbitrary 3.0%. There is a 2.0
percentage point positive difference between the two growth rates. The
firm has engaged in what is commonly called expense leveraging, at least
with regard to payroll.
The result is that pre-tax profits increase by 37.0%, from $200,000 to
$274,000. It is a classic example of using sales to leverage expenses.
Profits are increased even while payroll is rising at a modest rate.
Both the company and its employees are benefiting from the sales growth.
Conversely, the second scenario in the exhibit presents the opposite
situation. Sales continue to grow at the same 5.0% rate, but payroll
expenses increase by an equally arbitrary 7.0%. The sad result is this
increase in sales actually reduces profits.
The exhibit supports two major inferences, one of them
counter-intuitive, the other intuitive to the point of being
self-evident. Both of the conclusions need to be an essential part of
management’s thinking about profitability.
First, the counter-intuitive conclusion: slow sales growth can be highly
profitable. Sales growth of only 5.0% has the potential to deliver 37.0%
profit growth if expenses can be controlled. In far too many
distribution firms, a plan to produce both a low level of sales growth
and improved profits would be met with derision, though. Real men and
real women increase their sales at double digit rates. To achieve
anything less is to admit failure.
Second, the self-evident conclusion: sales and expenses must be planned
jointly. Too often they are not. In the two scenarios, the sales manager
will receive either accolades or brickbats for delivering the same 5.0%
sales growth. This is because the 5.0% growth rate that was achieved
either did (accolades) or did not (brickbats) meet the sales goal. The
sales goal is set in isolation without concern as to the expenses
required to meet the goal.
What needs to be brought into the calculation is whether the sales came
from high-expense activities or low-expense activities. The sales plan
must move beyond the amount of sales and also look at the source. It is
the difference between profits going up and profits going down.
Targeting Good Sales
From a financial impact, the figures in the exhibit are exciting. They
provide an absolute and unerring sense of direction for the firm. From a
motivational perspective, though, the numbers are decidedly unexciting.
In fact, bad sales growth is probably more exciting than good sales
growth. Two challenges have to be dealt with in motivating employees to
emphasize good sales over bad.
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Wanting What We Don’t Have—The grass is always greener on the other side of the fence. Adding customers implies the firm is moving forward. It is a natural progression in life. Penetrating existing accounts is boring. The value of customer penetration needs to be explained.
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Degree of Difficulty—Generating sales from new accounts is probably more difficult than generating additional sales from existing ones. However, it is seldom viewed that way. After all, customers are already buying “everything that they want” from us. Trying to generate incremental sales from existing accounts seems somewhat self-defeating. This negative perspective must be defeated.
The reality is that selling existing
products to existing customers is always the most effective way to
engage in expense leveraging. It needs to be given a much greater
priority in sales planning. New opportunities should not be overlooked,
but they should be balanced with efforts to grow organically.
Moving Forward
In the future sales planning must begin to incorporate the idea of
driving additional sales from the base of customers and products already
in place. That must be done not only from a financial perspective, but
from a sales management perspective.
About the Author: Dr. Albert D. Bates is founder and president
of Profit Planning Group, a distribution research firm headquartered in
Boulder, Colorado.
©2007 Profit Planning Group. SEDA has unlimited duplication rights for
this manuscript. Further, members may duplicate this report for their
internal use in any way desired. Duplication by any other organization
in any manner is strictly prohibited.
A
Managerial Sidebar:
A Checklist for Expense Leveraging
Any action that causes sales to grow faster than expenses is normally
thought of as expense leveraging. However, the concept can be expanded
to include sales remaining constant while expenses decline.
There are numerous actions that assist with expense leveraging. The
following are the most commonly discussed:
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Sales per Order Line—If the average line value on an invoice can be increased, then for the same level of expense, the firm generates more profit.
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Lines per Order—The idea of putting one more line on every order creates more sales, but only a little more expense.
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Order Accuracy—Any error of any sort on an order dramatically increases the firm’s costs. It also has a negative impact on customer perceptions.
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Fill Rate—When the firm is out of stock it goes to a lot of effort for no sales. A higher fill rate is always beneficial from a sales viewpoint. In most cases, the additional carrying costs of a higher fill rate are readily covered by the profit on higher sales.
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Order Frequency—If firms can work with their customers to plan purchasing requirements with greater accuracy, then the same sales can be generated with less activity. This is good for the company and is also good for its customers as they spend less time receiving orders.
© 2007 Safety Equipment Distributors Association
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Important links from this article
A Checklist for Expense Leveraging
Notes
The SEDA PROFIT Report helps member distributors benchmark their financial performance against industry averages. Participating firms receive an individual critique of their operation which lays out a specific plan for improving company financial results.