LIKE MANY INSTORE READERS , I enjoyed devouring the results of October’s Big Survey. Many of the results were to be expected, some were surprising. Sadly many of the disappointing answers were no surprise and served to reinforce the approach I hear from many retailers on a daily basis.
One of the most disturbing results concerned the method that many jewelers said they use to determine their store’s health. More than 50 percent saw sales as the sole criteria in determining if the business was doing well or not. While all businesses need sales in order to survive, relying entirely on this can lead to problems. Many a large business has become a statistic (we’d all love the revenue of many of the financial institutions that have hit the wall in the last 12 months) because they have neglected other key areas of their performance.
If margins are maintained, then sales can be as accurate an indicator as gross profit. But often stores will grow their sales at the expense of margin with the result that the extra revenue generated is producing an increasingly diminishing profit.
In the above chart our sample store has achieved sales of $1 million on a margin of 52 per cent during the first year. To grow the business, management has decided to focus on increasing sales with a strong discounting approach supported by more advertising. The result in year 2 has been an increase in sales of 20 per cent. On the face of it, this strategy appears to be a success. But there are a number of hidden factors that have contributed to what is actually a poor end result.
The discounting strategy has eroded margin with the result that the extra $200,000 of revenue has only generated an additional $44,000 of gross profit ($564,000 vs $520,000). Let’s not forget also that the discount strategy means that margin is being lost on the original $1 million of sales too — those people who were happy to buy at the higher margin are now reaping the rewards of the reductions. The business has effectively lost $50,000 of gross profit on this first million dollars of sales before it even starts to sell any extra. The business would have to be certain of achieving $1,106,382 from its reduced pricing structure to be sure of even getting back to its first year gross profit of $520,000 ($1,106,382 of sales at 47 percent margin would equal the $520,000 gross profit achieved).
But achieving a higher gross profit is only half of the problem. Extra sales normally result in higher overheads. To achieve these sales the store above has increased its advertising by $30,000 and has had to take on extra staff to cope with the increased volumes. More inventory has been required to meet the demand so the interest cost of holding this extra inventory has increased. The result has seen expenses increase by $80,000 ($30,000 extra advertising + $40,000 extra wages + $10,000 extra interest expenses). Given the gross profit increased by only $44,000 ($564,000 – $520,000) then this business is worse off by $36,000 ($44,000 – $80,000) than it had been in year one. The$100,000 profit in year 1 has declined to $64,000 in year 2 – and there’s been a lot more work required to get there.
Advertisement
So what should store owners concentrate on to measure their store’s health? No one factor is more important than the rest. At the end of the day, profit is the primary measure, however a lot of factors serve to achieve this profit and to concentrate only on profit can see you failing to take action until it is too late. A profit-only focus is like driving from one end of the street to the other by concentrating only on the horizon. You have to keep looking just in front of you to watch for the turns in the road, the pedestrians crossing, other cars and a myriad of factors that you must negotiate before you reach the far end. By all means keep your eye on that horizon but a successful business is built one step at a time and profit is only achieved by ensuring all the variables that affect profit are looked after.
Another worrisome result in the Big Survey was the 22 per cent of businesses that had no idea what their profit margin was. Let me ask you this: If you were an employee for someone else would you take on a job never knowing what your hourly rate or salary was going to be? Would you purchase an item of clothing from a department store and not ask how much you are being charged — just hand them your credit card and throw away the receipt without looking? Of course not, yet 22 per cent of those surveyed are effectively doing just that; working long hours (65 per cent of those surveyed are doing in excess of 45 hours per week) for an unknown reward if any. If you don’t know what profit you are making then pack the personal possessions you have in your store and walk out the front door and don’t ever go back. If you don’t care about the profit you are making then you shouldn’t care if the looters take your entire inventory. There are staff, vendors and customers depending on the ongoing continuation of your business and it can only continue if you are making a profit to survive.
What other factors are crucial for a business to measure? Aside from gross profit, net profit and expenses a business needs to keep a careful eye on its inventory. Having the right level of inventory is important — too little and sales will be lost, too much and the business will suffer cash-flow issues (see our article last month on the free “obesity” check we can give you regarding your inventory). It’s not just the level of inventory but the age that is also important. Aged inventory is dead inventory which is doing you no favors. Keeping your inventory fresh through new items and reordering good sellers is proven to increase business sales. Return on investment (often referred to as GMROI) is also crucial. This is a measure of how much gross profit you make for every dollar invested in inventory. There is no point in earning $200,000 per year if you have $10 million tied up in inventory to achieve it. You would get a better return by putting your money in the bank!
Determine the key factors for your business success and make sure you measure them on a regular basis. Take the actions steps you need to make your business a success today. If you need assistance with determining the key drivers for your business success.
