MHEDA’s 2010 DiSC Report outlines profit performance in a down year.
The recently completed 2010 MHEDA Distributor Performance Benchmarking Report (DiSC) provides detailed financial and operating benchmarks for the industry. This report highlights the distinction between the performance of the typical firm and the high-profit firm. The differences are important in normal times; they are critical in tough times. Two distributor studies were completed, one for lift trucks and one for storage & handling/engineered systems.
Typical Versus High-Profit
The typical firm in the survey is the firm with financial results in the exact middle of the results for all participating firms. That is, on any given measure, half of the firms performed better than the typical firm and half performed worse.
In the forklift market, the typical firm generates sales of $16,738,989. On that sales base, it produces a pre-tax profit of $150,651, which equates to a profit margin of 0.9 percent of sales. For storage & handling/engineered systems distributors, the typical firm generates sales of $5,353,560. On that sales base, it produces a pre-tax profit of $53,536, which equates to a profit margin of 1.0 percent of sales.
In both good years and bad, most firms tend to produce results that are relatively close to those of the typical firm. The challenge when the economy slips is that being typical is only good enough for survival. They are well below the level necessary to reinvest in the firm for the future.
In contrast to the typical firm, the high-profit firm, operating with the exact same set of economic and competitive challenges, generates a profit margin of 5.5 percent for forklifts and 6.8 percent for storage & handling/engineered systems. This means that even if the high-profit firm had the same sales volume as the typical firm, it would generate more profit for reinvestment in the firm that, in turn, will allow it produce even more sales and profit. This is an ongoing advantage which is amplified over time. Furthermore, it is an advantage that is almost always magnified in periods of recession.
Raising Profits in a Down Market
Generating strong profit results is never easy, but in a strong economy some level of profit is almost guaranteed barring unusual circumstances. Firms can rely on sales growth to overcome poorly managed financial aspects of the business and remain profitable. With more difficult economic conditions, every aspect of the firm is under pressure and inefficiencies are more exposed.
Reaching high-profit performance is a matter of identifying what factors are most important to producing profit and then developing a plan to perform better in those areas. In benchmarking terms, the important items are called the critical profit variables (CPVs). The CPV results for the typical firm and high-profit firm are summarized in Exhibit 1.
MHEDA conducts its Distributor Performance Benchmarking Report each year. Participating firms receive free copies of the results. For more details, contact the MHEDA office at 847-680-3500.
Two notes of caution are always in order when comparing typical and high-profit firms. First, no firm produces superior results for every single CPV in either good times or bad. Successful firms manage their CPV performance so as to maximize overall profitability. Second, the CPVs that impact cash flow are not the ones that impact profit.
In a soft economy, the phrase “cash is king” is heard often. This thinking leads firms to reduce assets—inventory, accounts receivable and fixed assets—to convert them to cash. This process is both understandable and, perhaps, desirable. However, it suffers from two key limitations.
First, the factors that drive cash are not the same ones that drive profitability. Cash may be an issue in a recession, but profits are an even bigger issue. The cash challenge inevitably arises because there are no profits to invest back into the firm. A serious problem arises when the “cash is king” mantra causes firms to take their eye off of the profit ball. Second, converting assets to cash often makes the profit challenge worse. If firms liquidate too many of their operating assets, such as inventory or accounts receivable, they lessen their ability to generate sales and may have entered a death spiral.
That’s why this analysis focuses on profitability. If firms are going to be successful in the longer term, they can’t just hunker down. They must continue to build the base for the future—higher profits.
In ensuring profitability in a soft market, four factors have the greatest potential impact on profit. These must be the center of planning attention. These factors are sales growth, gross margin, payroll expenses and non-payroll expenses. The firms that successfully control these four critical areas have a major financial advantage in slow times that tends to carry over into good times.
Sales Growth — The absolute level of sales volume is seldom a profit driver. Large firms may achieve economies of scale and may have advantages in purchasing. However, these advantages are frequently offset by the tendency of large firms to become bureaucratic. The real issue is sales growth. The pressing need in profit improvement is to focus on sales growth relative to expense growth. Ideally, firms should target sales increases somewhere between one to two percentage points faster than the increases in operating expenses.
In a growing market, maintaining the gap between sales growth and expense growth is not necessarily easy, but it does seem achievable. When sales are stagnant, or even declining, the degree of difficulty increases sharply. However, this sales-to-expense delta is always the key to profit.
Gross Margin — The ability to generate adequate gross margin is always a major determinant of profitability. Financial success over the long term demands strong gross margin performance. In periods of slow growth, there are intense pressures on gross margin but most firms can still find opportunities for significant margin enhancement.
Payroll Expenses — Payroll is by far the most important expense factor, which means that controlling payroll is essential to controlling expenses. In recent years payroll has rivaled gross margin in importance as a driver of profitability. This is because payroll expenses, especially the fringe benefit components, have increased relentlessly in both good times and bad over the past decade.
Non-Payroll Expenses — Most non-payroll expenses usually require only minor adjustment. Unfortunately, numerous expense categories must be examined and adjusted. Controlling non-payroll expenses will probably always involve examining every expense category with the goal of identifying options and making modest improvements.
Every recession eventually ends. Once it does, many firms will return to their “business as usual” routine. They would be well-advised, however, to remember both the challenges and opportunities associated with this recession. A company that can build its profit base in a down market will enjoy a major advantage on the upside.
|Meet the Author
Albert D. Bates, Ph.D., is president of Profit Planning Group, located in Boulder, Colorado, and on the Web at www.profitplanninggroup.com.