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Gross Margin Percent: A Poor Indicator of Profitability

Bruce Merrifield, President — Merrifield Consulting

•competitive strategy •profit analytics •profit training •profit strategy •QPM •business math for distribution •business analytics •Gross Profit Margin •customer profitability analysis •Bruce MerrifieldMost distributors have naturally occurring, high gross margin percentage (house) accounts and high gross margin percentage (small dollar pick) SKUs. Surprisingly, many of these are operating profit losers.

In reality, the gross margin dollars in these small dollar picks and orders amount to less than the cost to serve dollars they consume. This means they actually cost more money to fill than they generate in profit. In contrast, direct ship orders with low gross margin percentage are often quite profitable.

What matters at the line and order level, therefore, is not the gross margin percentage, but rather this profit equation:

Gross Margin Dollars – Cost to Serve Dollars = Profit Dollars

Note that gross margin percentage is not part of the equation!

In fact, a higher gross margin percentage will increase the gross margin dollars, but the even bigger cost to serve dollar total for excessive lines, orders, customers, and SKUs remains unmeasured, unknown, and larger than believed.

This informational blindness allows high gross margin percentage, losing sales activity to accumulate, and some low gross margin percentage, profitable direct orders to be overbid and lost.

Getting Rid of High Gross Margin Percentage Blind Spots

A simulation game with financial statements tells us that both selling high and buying low will improve gross margin percentage, gross margin dollars, and the flow-through of the incremental gross margin dollars to profits. So, we believe that higher gross margin percentage is good everywhere and always, which doesn't work on small dollar picks and orders!

Of course, don't underprice an outstanding service value if you have one. If you can increase the prices on some items and to some customers—and make them stick and not lose any business—then do it. Otherwise, these blind spots will hurt you as in the following examples.

The Buy Low, Sell High Myth

Buy low, sell high is a zero-sum, win-lose goal. Your gains are your suppliers' and customers' losses. But, what are your unmeasured costs for lost trust and increased price shopping and haggling costs? After years of haggling has profitability improved?

Financial analysis assumes that all the underlying transactions, variables, and dynamics summed up from last year are static going forward. They aren't.

Do you think you can service a few more incremental small picks and orders without increasing expenses? Distributors that do line item profit analysis discover, on average, that 70% of all lines have losing profit equations. And, 65% of all orders and 80% of all customers are losers.

Therefore, losing business eats all change ideas.

Learn and apply cost to serve (CTS) Math to significantly improve these statistics and cure profit losing equations. You can watch both sales and profits soar by taking the following three simple steps:

Watch this 3-minute video excerpt from our recently released Cost To Serve Math course.

Check out WayPoint Analytics and request a demo.

Attend the Advanced Profit Innovation Conference April 20th and 21st, 2017 in beautiful Scottsdale Arizona.

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For more information about Bruce Merrifield, visit: www.merrifieldact2.com


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