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have the potential to decrease sales.
Nowhere in the MIS is there a proper entry for the economic impact of
sales that are not made.
This report will examine the impact of lost sales on industry profit
performance. It will do that by addressing two key issues:
Understanding Sales Sensitivity—An examination of how even modest
missed sales opportunities decrease profitability.
Rejuvenating Sales Results—A discussion of the alternative approaches
available to management to drive higher sales volume without increasing
operating expenses.
Understanding Sales Sensitivity
It should be noted from the start that incremental sales volume is
almost always a mythological creature. The assumption that adding new
customers doesn’t increase costs because “the truck is going right by
there anyway” always proves inaccurate in the harsh realization that
expenses are incurred on every sale.
However, there are a few instances when incremental sales volume is a
very relevant and useful concept. This is particularly true in the
context of generating additional sales volume from the existing
operating structure. That is, selling more of the current product line
to existing customers. In such instances, the expense impact, at least
with respect to fixed expenses, is negligible.
Exhibit 1 presents financial information for a typical AVDA
member based upon the latest results from the PROFIT Report. As can be
seen in the first column of numbers, the typical firm generates
$150,000,000 in sales, operates on a gross margin percentage of 20.0% of
sales and produces $3,750,000 in profit or 2.5% of sales on a pre-tax
basis.
Like every firm in every industry, this
typical AVDA member has both fixed expenses and variable expenses. Fixed
expenses are overhead expenses that tend to be difficult to shed as
sales fall. Variable expenses, including things like commissions, are
expenses that rise and fall with sales volume. For analysis purposes,
variable expenses are assumed to be 4.0% of sales—a figure that would be
reasonably close for most AVDA members.
In the next two columns of numbers, sales have been increased by
5.0%.The second column reflects a sales increase with no change in
either the expense or gross margin structure of the firm. That is, the
firm really is selling more of its existing products to existing
customers without lowering its prices. Therefore, fixed expenses remain
the same while variable expenses rise with sales.
The impact on profits is significant. With a 5.0% sales increase,
profits increase by 32.0%, from $3,750,000 to $4,950,000.This clearly
demonstrates the sales sensitivity for firms in the industry. Once
again, this is all predicated upon finding truly incremental sales
volume, something easier said than done.
Unfortunately, the hunt for incremental volume is almost always
associated with price reductions to induce the incremental sales. Once
price reductions on incremental sales take place, price reductions on
almost everything tend to follow. Taking this path easily negates the
sales gain.
The final column of numbers examines the gross margin reduction that
would exactly offset the sales increase and leave the dollar profit
number unchanged. The figures in this column are not intuitive, so they
need some additional explanation.
In the second column, sales cost of goods and gross margin were all
increased by 5.0%.In the third column, the increase in cost of goods
sold associated with more sales stays where it was in the second column,
at $126,000,000.However, prices on the same physical volume are reduced
by 0.8%, so sales do not reach the $157,500,000 level. Instead they only
increase to $156,250,000.At the lower sales level and the same cost of
good sold, gross margin falls to 19.4% of sales.
The net result is that dollar profits do not improve, but remain where
they were originally. However, the firm is working 5.0% harder to
generate the same unit sales. The important message is that incremental
sales volume is a wonderful concept when it truly is incremental.
However, the opportunities to destroy the profit impact of true
incremental sales abound. To be successful, fixed expenses must stay
fixed and the gross margin percentage must not fall.
Rejuvenating Sales Results
At first blush, generating incremental sales volume in a sluggish
economy would appear to be virtually impossible. The reality, though, is
that many of the actions that firms take to diminish the financial
burden of the recession actually end up lowering sales. Sometime not
doing things that hurt is as important as doing things that help. Three
of these issues are particularly important:
• Inventory Reductions—Almost every firm has tried to reduce inventory
for cash flow reasons. The almost universal reality is that sales suffer
from an increased frequency of out-of-stock situations. Clearly, firms
are caught between an inventory “rock” and a sales “hard place.” While
inventory reductions may be necessary, they need to be highly targeted.
Blanket cuts in inventory levels or management edicts to cut purchasing
must be avoided.
• Accounts Receivable Reductions—This follows an almost identical
logical process as inventory reductions discussed above. Certainly bad
debt problems increase in a down market. However, every reduction in a
customer’s credit line is a potential sales opportunity that is missed.
• Lag in Add-On Selling—Every salesperson has been beat up by the
recession in some way. One result is that the enthusiasm for add-on
selling is greatly diminished. The quickest way to drive incremental
sales, though, is to cajole or motivate the sales force into making an
extra commitment to this process.
Moving Forward
Economic conditions have created measurable sales challenges for almost
every AVDA member. I n too many cases, though, cash flow challenges have
caused firms to make the problem even worse. In particular, reductions
in inventory and accounts receivable often hurt sales as much as they
help cash flow. In addition, management teams that are stretched thin
often do not monitor sales productivity—as opposed to total sales--to
the extent that they might otherwise. As a result, sales per salesperson
causing can fall. If these issues can be dealt with directly, some sales
relief can be achieve. The impact on the bottom line can be dramatic.
About the Author: Dr. Albert D. Bates is founder and president
of Profit Planning Group, a distribution research firm headquartered in
Boulder, Colorado.
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