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three different pressure
points should be addressed:
Sales Volume—If additional sales can be generated with the same gross
margin percentage and the same dollar commitment to payroll, then the PPR will fall.
Payroll Costs—Any cut in payroll that does not result in a reduction
in sales will clearly lower the PPR.
Gross Margin—If the firm increases its gross margin percentage on the
same sales volume, the PPR will also fall.
In most instances, management uses a blend of actions to bring down the
PPR. What is most important to remember is that any group of actions
that lowers the PPR will simultaneously generate higher profits for the
firm.
The Economics of Payroll Control
Exhibit 1 examines the financial impact of the three major options to
improve the PPR identified above. Exhibit 1 presents information for the
typical AVDA member—the firm producing mid-point performance on sales,
gross margin, PPR and bottom-line profit. While every firm is somewhat
unique, the figures in Exhibit 1 reflect how profit results will change
as the PPR is lowered.
The first column of numbers simply reviews the typical firm’s
performance. The firm generates $150,000,000 in sales which produces
$3,750,000 in profit before taxes, or 2.5% of sales.
The next three columns examine what would be required to reduce the PPR
by exactly 2.0 percentage points if the three actions were taken
individually—either increasing sales, lowering payroll or improving the
gross margin percentage. The 2.0 figure is merely illustrative. Some
firms can lower the PPR more in a single year while others have less
potential for improvement. However, two points is a reasonable goal for
most firms.
The second column of numbers indicates that if sales rise by 4.3%
(actually 4.329% for the purist reader), then the PPR will be reduced by
exactly 2.0 percentage points. The ultimate implication of a sales-based
approach to lowering the PPR is that profit will increase to $5,048,701,
or 3.2% of sales.
The sales-based strategy is dependent upon two very crucial assumptions.
First, the gross margin percentage must be maintained at 20.0% of sales.
This means that price cutting cannot drive the sales increase. Second,
payroll expense remains at the same dollar level, namely $14,460,000.
The implication of this is that as sales recover, the first 4.3% of
sales increase must go to improving performance, not to providing
compensation increases to employees, regardless of how deserving they
may be.
The third column of numbers examines the reduction in payroll expense
that would be necessary to lower the PPR in light of no increase in
sales volume. The required reduction is 4.1%, just slightly smaller than
the 4.3% increase in sales required to achieve the same reduction in the
PPR. Despite producing the same reduction in the PPR, the increase in
profit is smaller with expense reductions than with sales increases. The
resulting profit is only $4,350,000 or 2.9 of sales. It is still a
significant increase.
Finally, if the gross margin percentage can be improved by 0.9
percentage points (increasing from 20.0% to 20.9%), then the PPR will
also fall by the same 2.0 points during the year. This approach produces
the same exact amount of gross margin dollars and the same amount of
profit as the sales increase approach. For the sake of simplicity, the
example assumes the margin is increased via improved buying. A price
increase model would have produced almost virtually the same financial
result.
Each of the three approaches has its own challenges. Regardless of which
approach is selected, it is clear that a 2.0 percentage point reduction
in the PPR increases profits significantly. It is a reasonable starting
point for planning.
Moving Forward
Economic conditions have caused payroll expense to once again come to
the fore as a significant issue. Given continued uncertainty in the
economy, firms need to take a multi-faceted approach to controlling
payroll. The PPR is the best tool available to evaluate the success of
those actions.
About the Author: Dr. Albert D. Bates is founder and president
of Profit Planning Group, a distribution research firm headquartered in
Boulder, Colorado.
©2009 Profit Planning Group. AVDA 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: Three Quickies for Lowering the PPR
For the most part lowering the PPR involves time-phased, long-term
commitment to a number of initiatives. However, there are a few things
that can be done quickly. The following represents but three examples:
Sales Volume—Probably the fastest way to increase sales, especially in
a down market, is to generate more lines on every order. Only a very
small change is required to generate higher sales without any increase
in payroll expense (other than commissions). The sales force is probably
tired of hearing the plea to put more lines on every order, but it is a
plea worth making again.
Payroll Expense—Most firms provide a wide array of extremely valuable
services that their customers relish. They also provide a few services
that customers don’t ever use or view as having almost no value. The
quickest way to lower payroll expenses is to stop doing the things that
have limited or no value to customers.
Gross Margin—Virtually every firm routinely under-prices slow moving
merchandise. Yet, there is an incredible value added for customers by
having inventory of slow-selling items available when they are needed.
That value added is worth a slightly higher price.
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