by David Brown
Like many readers, I am always devouring the results of Instore Magazine’s Big Survey of Instore readers. Many of the results were to be expected and some are surprising. Sadly, many of the disappointing answers were no surprise and served to reinforce the approach I regularly hear from many retailers.
One of the most concerning results was the method that many jewelers use to determine their store’s health. Over 50% saw sales as the sole criteria in determining if the business is doing well or not. While all businesses need sales in order to survive, relying entirely on this can lead to problems. Many large businesses have become a statistic (we’d all love the revenue of many of the financial institutions that have hit the wall in the last twelve 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 being done so on an increasingly diminishing profit. Let’s illustrate with an example:
Year 1 Year 2
Sales $1,000,000 $1,200,000
Margin 52% 47%
Gross Profit $ 520,000 $ 564,000
Wages $ 120,000 $ 160,000
Advertising $ 30,000 $ 60,000
Interest Expense $ 20,000 $ 30,000
Other Expenses $ 250,000 $ 250,000
Net Profit $ 100,000 $ 64,000
In the above example our sample store has achieved sales of $1 million dollars on a margin of 52% during the first year. With a strong focus on sales the management has decided to focus on increasing sales with a strong discounting approach promoted through increased advertising. The result in year 2 has been an increase in sales of 20% – on the face of it this strategy appears to be a success. But there are a number of hidden factors that have contributed to a poor end result. The discounting strategy has cost margin with the result that the extra $200,000 of revenue has only generated an additional $44,000 of gross profit ($564,000 – $520,000). Let’s not forget that the discount strategy means that margin is being lost on the original $1,000,000 of sales also – those people who were happy to buy at the higher margin are now reaping the rewards of the new 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 ($520,000 gross profit in year one – ($1,000,000 x 47% margin in year 2). 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% margin would equal the $520,000 GP achieved).
But achieving a higher gross profit is only half of the problem. Extra sales normally result in higher expenses. 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. $100,000 profit in year 1 has reduced to $64,000 in year 2 – and there’s been a lot more work required to get there.
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 it, profit is the primary measure, however a lot of factors serve to achieve this profit and to focus only on profit, can see you failing to take action until it is too late. A concentration on profit only, is like driving from one end of the street to the other by focusing 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. But never forget that profit is ultimately what you must achieve.
Another concerning result in the survey was the 22% of businesses that had no idea what profit they were making. Let me ask you this question…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% of those surveyed are doing just that; working long hours (65% 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 possession you have in your store, 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. 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 re-ordering fast 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 $10,000,000 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.