Putting the Brakes on Sliding Profits
As entrepreneurs, we all have a handle on the cost of operating our businesses. As distributors, we learn to measure these costs as a percentage of our sales. We then determine a markup for the products that we sell in order to cover those costs, plus a little something to bring us back a fair return on investment. Current conventional wisdom in the automotive aftermarket suggests that a jobber should make between 32% and 35% gross selling margin to be healthy.
Certainly, you don’t need another math lesson to teach you the difference between a cost and a selling margin. We all got over that hump 30 years ago. There is, however, some new math out there that we must learn soon if we still want to own a business five years from now.
Competition over the past decade has adopted a new weapon called the short line. It’s not like it hasn’t been around before–for years we’ve been selling the odd cheap gas filter and spring kit–it’s just that it has grown to the point where we are now required to carry two different brands for just about everything that we sell.
The way in which we price those second lines will determine in short order exactly who the survivors will be. Consider this typical scenario:
Last year you took on a few second lines in order to match the pricing of your competitors.
Your sales reports suggest that you’ve gained some ground in terms of number of deliveries and profit margins are up three points over last year, but your accountant is telling you that you’re not making ends meet anymore. How can that be?
A couple of years ago, you bought a brake rotor for $30 and sold it for $50. Forty points, that was the life! Then last year your competition was beating down the garage’s door with a Chinese product that he was selling for $37.50. You take some heat for a while, drop your margin down to 30%, and even lose some sales before you finally relent and take on a cheaper priced line. The second line rotor for the same application costs you $15, so you turn around and sell it for $26.95. “I sure showed him!” you tell yourself, proud of the fact that you succeeded in undercutting the competition by 18%, all the while increasing your selling margin to 44%! “Hey, not bad, now let’s have another look at those cheap suspension parts…”
Slowly but surely, your financial health is weakening, but for the life of you, you can’t figure out why.
It’s time for your millennium math lesson. Last year, you made $20 on the sale of a brake rotor. This year you made $12 to fill a similar order.
That’s 40% less gross revenue. If half your rotor sales were made with the same markup method, your net revenues would be down 20% over the previous year. To make the same bottom line profit, assuming a 30% gross margin, your expenses would have had to be reduced by 28.5%! When was the last time you saw your fuel, telephone, electricity and staffing costs go down?
Millennium math suggests that when pricing second lines, we should make as close to the same gross dollar revenue that we would have otherwise made on the first line. In the case of the brake rotor, take the same $20 that you would have made on the first line rotor, add it to your cost of $15 and sell it for $35 or even $37.50, the same as the competition.
If you apply this logic to all your second lines, the new millennium will see you healthy, wealthy and wise.
Reprinted with permission from “The Raw Facts,” newsletter published by Regional Automotive Warehousing.
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