PROFITABILITY for most truck equipment distributors isn't as good as it should be given the hours that they work, according to Dr Albert Bates, president, Profit Planning Group.
Bates company, Profit Planning Group, conducts an annual profitability survey of NTEA distributor members. The survey groups distributors based on profit performance and return on assets. He noted that distributors can make small changes to their pricing that will yield increased margins under competitive conditions. Bates discussed the impact of price changes on overall gross margin. He recommended a two-pronged pricing strategy.
Distributors today are forced to remain competitive by lowering prices but cannot afford to reduce profits. The first part of Bates' strategy limits the price battle to the top 10% of the product mix. Prices are cut only on items that make up the top 10% of a company's sales.
"As sales decrease, gross margins must increase," Bates said. "Products that make up only 5% of a company's sales should yield a 47% gross margin."
Changing Prices Under these conditions, a price cut of 5% on high-volume sales items only will result in a .4% loss of total gross margin. "This shows that if you can limit the price battle to 10% of the company's sales, you can live through the price battle," Bates said. His example follows:
Margins can be raised under the same conditions by changing prices on items that make up 20%, 15%, and 5% of a company's gross sales volume when prices are cut 5% on its fastest selling items. Raising the price of the least selling products by 31% instead of 5% will raise margins 1% as follows:
"If customers are buying hard to find, value added items because you have them is stock, you have got to get paid for that added value," Bates said. This is the second part of his two-pronged plan.
Bates summarized the goals of his presentation using a mandate for change consisting of:
An actual sales increase of 6%
A real sales gain or expense increase of 3%
A gross increase of .3%.
An increased turnover of .1%
No change in collection time
"These objectives, if achieved, will yield a 19.7% increase in return on assets in five years," Bates said. "If you go back and do these things in your business every year, you'll make as much money as you deserve to make."
Improving ROA Bates' plan is designed to help companies improve their return on assets in five years. He gave NTEA members a formula for setting a profit target. The first step is to calculate the company's return on assets by dividing its previous year's profits by its end-of-year assets. Next, the calculated return on assets is added to a desired improvement in return on assets of 2.5% to 3.0% to calculate a target return on assets. This number is then multiplied by the company's end-of-year assets to generate a target profit figure.
"If companies do this every year they will generate more profit," Bates said.
He then listed six improvement areas that if changed by a given percentage will double profits. Changes including raising prices by 2.3% or buying 3% cheaper will double a company's profits, according to Bates.
Bates made five assumptions as part of his plan to achieve a 20% return on assets in five years. Bates' assumptions are:
The CEO is underpaid
Expense creep is alive and well
Sales have not grown dramatically
Planned sales are very strong
Gross margin is under some attack
"Expense creep of 3% will result in a 26% loss of profit in four years if nothing is done," Bates said. "If sales, cost of goods, gross margin, and expenses go up 3%, profit will climb at the same rate." He used an example from actual NTEA results.
Bates listed three plans that companies can use to reduce expense creep: slow growth, rapid growth, and downsizing.
Under the slow growth plan, sales, cost of goods, and gross margin increase by 6% while expenses increase by 3%. This will yield a 32.6% increase in profi t in five years.
"NTEA survey results over the last 10 years show no real increase in sales, they've gone up at the same rate," Bates said. "Sales must grow faster than expenses."
Bates' rapid growth plan calls for a 10% increase in sales, cost of goods, and gross margin while expenses climb 7%. This yields a 36.6% increase in profit over the same period. "It doesn't make any difference how fast the sales grow, as long as they grow faster than expenses," Bates said.
The downsizing plan calls for maintaining stable sales, cost of goods, and gross margin while dropping expenses 3%. This approach will increase profit by 26.6% in five years, according to Bates.
"Make the calculations every year," Bates said. "Know where your company stands at the end of every year."