Based on my experience, the average building supply business in North America earns in the neighborhood of 2.5% before income taxes. If the owners of a business with this income stream wish to sell, the odds are they’d receive no more than the value of their assets, if that.
On the other hand, a strong building supply business with a relatively high sales volume that earns 8% to 10% (top dollar) before taxes would likely sell for six to eight times earnings.
So, what is the secret to top dollar earnings? Number one is having a highly competent general manager at the helm who is committed to achieving optimal earnings by fielding a team of managers and salespeople who have a burning desire to optimize sales and profits and the discipline to run their segments of the business by the numbers.
Are there segments of your business where you’re running blind?
Statistically, running blind is management’s most common mistake. Running blind is largely a failure to keep score. Do you have too many people? If so, how many?
If your expenses are too high, it doesn’t mean that all of your expenses are too high. The trick is to analyze your performance measurements to determine which expenses are too high and which may even be too low.
In my job as a business consultant, I frequently find the problem with profitability is money falling through the cracks, but the management doesn’t have the benchmarks in place to identify them.
Because personnel-related expenses are the lion’s share of total expenses, this is where I generally begin. To earn top dollar, the rule of thumb I use is controlling personnel-related expenses to 60% of total operating expenses. Personnel-related expenses include:
- Compensation (salaries, bonuses, commissions, )
- Worker’s compensation insurance
- Group medical
- Payroll taxes
- Profit sharing
Other useful benchmarks: Delivered sales per truck (consider the capacity of each truck)
- Returned merchandise as a percentage of sales
- Shrinkage as a percentage of sales
- Bad debt expense as a percentage of sales
- Percentage of past-due customers in each aging field
- Sales expense as a percentage of sales and gross profit
- Overtime compared to plan
Outside sales compensation
Outside sales compensation as a percentage of sales will usually vary to the geographical location of the business, but my rule of thumb is 3% of sales or 13% of gross profit dollars. Some successful managers combine the two and don’t allow outside sales expense to exceed 16% of these two combined.
Personal best
Where these metrics really begin to open management’s eyes is when they begin to see areas of significant improvement. I use the personal best concept of measurement that is so often referred to during the Olympic Games. After each performance in the Olympics, you are likely to hear the commentator say that the athlete achieved the best performance he or she has ever achieved, meaning that he or she achieved a personal best statistically.
This is why I believe athletes around the world are lifting more, jumping higher, and running faster than they ever have in the past—because they keep score. They are not running blind.
Gross margin
The LBM businesses earning top dollar are almost always optimizing gross margin. Optimizing gross margin doesn’t mean shooting for a 25% GPM on studs and OSB, two of the most shopped commodities in our industry. But it does mean substantially increasing your current gross margin on many of your slow-moving SKUs, getting out of the markup rut on special order products and teaching your pro sales force how to deal with price objections. If you were to visit the most highly-rated business school in your region of the country and ask the leading professor in that school what determines the price a business should ask for the material it sells, what do you believe the answer would be?
I’ll tell you that most salespeople will answer cost, and more than a few store managers will as well. Maybe this is why the sell price of so many products in our industry is determined by marking up the product’s cost.
If you answered cost, then you’re almost certainly leaving several points of gross margin on the table. The correct answer is: what the market will bear; that is, what someone will pay you for the product.
Once you have zeroed in on the gross margin your market will tolerate, begin to slowly and conservatively test the market. If your gross margin on a given SKU is running 27.3% for a few weeks, try 27.6% and see what happens. If you don’t get any push back, try 27.8%, etc. Test, test, test the market.
Beware of the markup rut
Over the 33 years I have served our industry as a consultant, I have observed the majority of LBM businesses relegate pricing on oftentimes thousands of SKUs to inside or outside salespeople, most of whom are in a markup rut with their customers. Beware of the follow- ing signs that management is allowing the markup rut to govern the price your company charges its customers:
- Using round number markups on cost to arrive at retail prices, i.e., markups that end in a zero or a five. 33-1/3% is popular as well.
- Adding in shipping and handling charges at cost.
- Observing that virtually all salespeople have their own personal formula for arriving at a sell price on special order sales when special order sales average between 25% and 40% of the typical dealer’s total sales volume.
- Observing that many salespeople are insecure about the competitiveness of their price list.
- The LBM company offers salespeople little to no guidance for pricing special orders.
Based on what I see in the field, salespeople are often more price conscious than their customers are. Here’s what I ask salespeople: “In thinking about your annual sales, do you believe your customers are paying you a premium on the sales volume they are buying from you?”
The answer is no! Your customers are buying from you because after considering all options, they believe they are getting a darn good deal.
Coach salespeople how to deal with price objection
Either volunteering a price cut to induce a customer to give the salesperson the order, or giving in to the customer’s negotiating tactics over the course of a year costs LBM companies three to five gross margin points.
Negotiating is a skill. Some customers are experts at persuading salespeople to reduce the price they are authorized to quote. To have a prayer of holding their prices when customers insist on a lower price, salespeople must be aware of their options. Many of your customers may have learned this, but how about the salespeople in your company? Have they been taught how to compete?
For many untrained salespeople, it’s much less stressful to agree to a lower price than to try to explain why the price they quoted is competitive. The ability to protect the company’s pricing structure requires training and practice. Owners and managers who wish to optimize profitability must give price cutting serious attention.
If you don’t know precisely how much your salespeople are reducing the prices in the price book, consider keeping score to find out.
Profitability analytics software
Any industry that inventories several thousand SKUs turning at dozens of different rates cannot possibly be aware of the dynamics of each SKU. Consider inter-company transfers, branch locations, inside and outside salespeople, returned merchandise, pickups and deliveries, CODs, credit losses, credit card transactions, etc. The variables are mind boggling even with state-of-the-art industry-specific
software. Without profitability analytics software, I believe it’s foolish to think managers have the time, patience, and attention to detail to figure out how to optimize profitability, especially when so much of the pricing is in the hands of the sales force.
Let’s face it, the consolidated financial statement fails to reveal the specific location of profound profit variables within the business. From the transaction-level through the vendor/product family, customer, sales territory, and branch, there are substantial variances and distinctions in net profitability that are obscured by revenue and gross margin statistics that are generally used to assess successor viability.
Each business’s definitive net income results from the tension among three distinct groups of customers and products:
- Profit-makers: products and customers that contribute to peak internal profitability.
- Profit-neutrals: products and customers that either maintain or match peak internal profitability.
- Profit-takers: products and customers that reduce the peak internal profitability to actual net profitability.
The difference between peak internal profit and real net profit is profit opportunity. By remediating profit-takers, improving profit-neutrals and growing its profit-makers, the organization can point its resources toward optimal profit growth. Also, because two customers generating the same gross margin can consume organizational resources at different rates, a deeper level of analysis is crucial to understanding true profitability.
Regrettably, most managers don’t know where products or customers fall within the categories mentioned above. Thus, they fail to identify and mitigate profit-takers, reducing net income, and enterprise value. Additionally, they often fall short in focusing sales and support teams on those segments that drive profitable growth and market leadership.
Interestingly, many executives believe that their largest customers and product categories are their most profitable—however this is frequently not the case. Often sizable customers and categories, when their true cost-to-serve is appropriately attributed, can be found across all three profitability groups. Because each product or customer is different, their gross profit contributions do not equally add to the ultimate net income of the business.
Earlier I mentioned that I believe, “what the market will bear,” should be the deciding factor in determining how to price a given product. While many major product categories are highly competitive, and customers oftentimes “shop” these products before making a buying decision, there are hundreds—sometimes thousands—of obscure products that are so inconsequential that customers simply cannot justify the time and energy it would take to engage in a hard-bargaining purchasing strategy. Today, there is software available that provides a handsome return on investment that monitors your inventory, identifies the specific SKUs that have the turnover to justify special pricing opportunities, and gives you reports that identify how much gross profit your company is generating as a result of the pricing matrix.
Cleveland-based SPARXiQ is one company that impresses me with the value they have to offer the LBM industry. The software was developed to provide an integrated sales and pricing analytics platform along with performance skills training to help contractor sales-people add greater value for their customers. Using SPARXiO’s or a similar company’s pricing principles, I believe building supply businesses can generate the kinds of gross margins these types of convenience items require.
SPARXiQ/Epicor partnership
SPARXiQ and Epicor have built a partnership to develop a strategic pricing module to make it easier for P21 and Eclipse users to take advantage of SPARXiQ pricing services. In my opinion, this module enables users to achieve initial margin improvement more quickly and reduce the resource time needed to implement the strategic pricing initiative.
SPARXiQ and Epicor have built several standard reports into the P21 and Eclipse module designed to help users measure this initiative’s margin impact and identify opportunities for further improvement. Through the use of the Epicor module, I believe SPARXiQ can efficiently lead users through the implementation process, resulting in less risk and quicker time to margin improvement.
I encourage you to follow the path outlined in this article, which I think will dramatically increase profitability.
Bill Lee is a respected sales and business consultant in the LBM industry. For more information, contact Bill at leeresourcesinc@gmail.com
