A Secret to Increased Profitability
Most distributors make lots of profit on their large orders, but then give over half their profit back on the small orders. If you are happy with your company sales dollars but frustrated by your low company profit, analyzing your orders might provide you with the information you need to make some changes and improve your results.
It is very common for distributors who go through this analysis to reduce their number of orders by 20% and reduce their sales dollars by 5% while raising profits significantly.
Your overhead cost to produce each order is fixed, regardless of the order size. Sales reps typically set the profit margin while the distributor is stuck with this fixed cost to pay for while also trying to make a profit for the company. Interesting dynamic for sure!
Let’s do some simple math for a small, $300 order.
$300 order at 50% GPM = $150 Gross Profit
40% sales commission = $60 to the sales rep
That leaves $90 to cover admin costs and profit
Average distributor overhead = $100-$150 per order
= MONEY LOSING ORDER
Most distributors lose money on ALL orders under $500!
How to Analyze Your Book of Business for Profitability
Several reports are suggested to help determine the profitability of your orders - average order size, median order size, and gross profit margin.
Most distributors know their average gross profit margin and we have discussed previously the importance of having a good profit margin to average order size ratio. The bottom line is, the lower your average order size, the higher the average gross profit margin needs to be to maintain profitability. The industry average is around 33% - 34%.
Divide sales dollars by the number of orders to get your average order size. The industry average is around $1000.
But average order size can be misleading if you had a few very large orders that skewed your average. Run a sales report that ranks all your orders for the year and find your median order size. If it’s a lot lower than your average order size, review your gross profit margin and see if it makes sense.
Run that ranking report again and include the gross profit margin for each order. Do all those small orders have high GPMs or do you have a bunch of sub-$500 orders at 35%-40% margin? Remember, these are costing you money!
Sometimes, it makes sense to take a small order even though you know you are going to lose money on it. That great client that spends $20,000 per year with you via 5 large orders might occasionally need a small order filled. So, of course, take the order as the client is profitable overall.
But if the client spends $20,000 via 100 small orders, they are likely costing you money and you might be better off without them.
First, fire money-losing clients. Do the analysis and then take action.
Second, adjust your compensation plan to encourage your sales reps to focus on money making clients – that’s money making for both the rep and your company. Establish minimum order sizes to qualify for commission. Maybe start at $250 and gradually raise it over a few years to $500. Reps will now start qualifying clients and prospects based on what’s good for them, which is in alignment with what’s good for your company.
And if a rep decides they need to write a small order for a good client, that’s fine. But that doesn’t mean you have to pay them commission. You’re going to lose money on that small order and so will the rep. But they have decided it’s worth it and your company will support that decision.
Once you are processing fewer small orders and have your sales reps focusing on quality clients with more quality orders, profits will go up. The next step is to prospect for more quality clients and have your admin staff spending more time processing profitable orders and less time processing money-losing orders. The results are obvious.
Learn more strategies to help your business grow!