She works hard for the money: just be sure she works smart. Photo courtesy of MorgueFile.com.
MEET THE AUTHOR |
CAROLYN TOPP is a Business Planning Consultant with over 20 years of experience in advisory services and business development for companies in the retail and consumer products industry. She held senior management positions in strategy, corporate finance and planning for Ernst & Young, Coach and Tommy Hilfiger. Early in her career she was a retail buyer for Bergdorf Goodman; she began her career as an associate for Goldman, Sachs & Co.
Carolyn has extensive general management knowledge and capabilities in financial planning and reporting; operations and inventory management; merchandising; product development; brand positioning; marketing and distribution. She works on a variety of business planning, product and marketing initiatives for a diversity of businesses including start-ups and not-for-profits.
Click here to contact Carolyn. |
July 2005
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Grow Your Business
Without Marginalizing Profitability
Some Practical Advice to Avoid the Pitfalls of Sales Growth
At the Expense of Profit Margins
More money will drop to your bottom line with this advice
from business planning consultant Carolyn Topp
Many businesses can get so caught up in running their day-to-day operations that they frequently react to what appears to be a good opportunity before understanding the likely financial impact of taking that course of action. Obtaining new customers, entering new distribution channels, expanding production, increasing the number of products for existing customers and coming up with a special customer promotion are all obvious paths businesses take in order to grow. However, since profitability is essential to business success, organizing and understanding financial information by identifying key ratios can help most business make better choices and more intelligent decisions.
Understanding Expense Flexibility
Know the ratio of total expenses to sales (as a %), as well as each separate expense category ratio to sales for all S, G & A (Selling, General and Administrative) expenses.
- What expenses are fixed and don’t change regardless of sales? What is this current % ratio to sales? What is the minimum in gross margin dollars that must be generated to cover these costs?
- What expenses are variable and change according to sales? What is their % ratio to sales? What would cause these ratios to change (increase or decrease), or will they remain constant with sales growth?
Case Study
Last holiday season, Internet customer demand was much greater than anticipated for a gift food product. The company had to stop taking customer orders because they didn’t have the production capacity to meet the demand.
They do not want to repeat this experience for the upcoming holiday season. However, before investing in a new production facility and warehouse, they should have an understanding of the cost and ratio implications for fixed expenses, including rent and equipment. They must also analyze costs of employing full-time personnel that would primarily be needed only to meet an anticipated—but not guaranteed—seasonal customer demand.
Based on these parameters, is the investment practical when evaluating fixed costs (on a percentage basis) vs. contract production and other outsourcing options—including temporary seasonal help, customer service and distribution?
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The Bottom Line: For some companies, variable expenses with defined ratios in line with operating margins can have financial advantages and less investment risk than developing fixed expense infrastructures. This may be especially true for businesses without an established customer base, an unproven sales history and dependency on seasonal sales peaks.
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Cost of Goods (COGs) Components and Gross Margins For Individual Products
Typically, a specialty food business may start out by selling one or two key products; over the first few years the assortment grows as the result of customer special requests, creating new products with new ingredients, sizes or packaging options, and/or adding new and complementary products.
To fully understand operating costs and profitability, it’s important to identify the margin components for each individual product and product category separately: ingredients, labor, packaging and shipping. This provides a much clearer financial picture than if you were to lump the cost of goods of all your products together.
- Are there wide variances between the gross margins on specific products and product categories?
- Are all costs relatively comparable between products?
- Are there duplicative choices offered to customers with margin variances (the same product in different packages, for example)? Do you need to offer both?
- Can every product and category stand on its own? Would the business be profitable in the event that a product or category becomes “high demand” and has a disproportionate sales increase relative to the other products in the assortment?
Case Study
Businesses will often come up with a variety of marketing reasons to justify carrying “loss leaders,” or even agree to sell an unprofitable product at a high volume to certain customers. Vlasic Pickle is one of the best-known examples of a company that made a wrong product pricing decision, eventually leading them to file for Chapter 11 bankruptcy protection: they agreed to sell vast quantities of a one gallon jar of pickles to Wal-Mart at a price that could never make them money.
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The Bottom Line: Only carry products to sell at prices that offer an economic value to customers and still cover the cost of business. |
Understanding Distribution Channel Requirements
All major retailers—department stores, grocery retailers and mass-market chains—require a substantial financial commitment from their suppliers. Some typical retailer requirements include:
- Co-op advertising support
- Staffing support and/or sales incentives
- In-store signage/displays
- Trade deals/coupons/circulars
- Selling through a sales and/or distributor network
- EDI order systems
- In-store events
- Promotional items
- Opening order discounts
- Charge-backs allowances and returns
Case Study
A company launched a new line of personal care products in the natural and health food industry and accepted at face value the “common practices” that they were told this channel required. This included:
- A 20% opening order discount for every new retail outlet
- A 12% sales commission for a sales team that was needed in order to work with the distributor network
Right out of the gate, it cost this company 32% for each opening order, without accounting for any of their own operational expenses; as well as the additional retail support expenses they would still incur for in-store merchandise displays, in-store events, sales materials, samples and advertising. In addition, the sales and distributor commission structure and related incentives were fatally flawed because it was easier to sell and open many new outlets with a 20% discount than to focus on more profitable re-orders at full prices for existing outlets. In 12 months this company had achieved a negative EBITDA (earnings before interest, taxes, depreciation and amortization) that had exceeded their gross sales. |
The Bottom Line: Know the support requirements for a major retail channel of distribution. Identify and understand if, or at what scale, the business’s gross margins and operating structure can achieve profitability based on these requirements. Establish incentives that are aligned with profitability. |
Net Net
We’ve all chuckled at the anecdote about the salesman who tells his boss, “We’re losing money on every unit. But don’t worry—we’ll make it up in volume.” Unfortunately, for too many businesses, it’s not a joke—it’s reality.
But with careful planning and ongoing analysis, you can make sure that you have the last laugh.
Carolyn Topp welcomes your suggestions for future topics that she can address on business planning and profitable business management. Click here to e-mail Carolyn.
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