MYOB: Math, Margins and Managing For Success

At all levels the industry is feeling enormous pressure from the margin squeeze on hard goods that has arrived at their doorstep.

The fact is the entire industry is in a race to the bottom in its pricing. This proves that the industry is more concerned about creating activity rather than profitability, and unless companies start changing their way of going to market the industry fallout will continue, with thousands of people getting hurt. Remember we are in the people business. That is who we are. Yet the corporate decisions being made on price, and the actions being taken, are harming the very soul of our industry.

It seems that in too many service shops and in too many jobber stores, there is always some person who wants to cut prices. They perceive that if business is good, a lower price will help capture an even greater share of the marketplace. On the other hand, they also reason that if business is bad, cutting their prices will help retain their existing share of the market.

Shops and jobbers must clearly acknowledge one very important point: they cannot cut prices without cutting service or quality. It is impossible in our sector of the industry to be the very best and be the cheapest. In the service provider business we counsel that there are three things to base a business on: price, service, or quality–pick two. In the jobber business we counsel on price, fast, or right, pick two.

In either case, once you land on price you have to give something else up.

The fact is that most shop owners and most jobber owners do not charge enough for their products or services. When business is good, you need cash to fuel growth, cash that could be generated by higher margins. When business is bad, cutting prices often makes matters even worse. You have to increase sales significantly just to recover the dollars lost by the price cuts.

Cutting prices, or charging too little, can have a very disastrous affect on your business. Please consider the following example, and study the math:

Suppose that you sell 100 units of a certain item per month at $1.00 each. They cost you 55 cents each, giving you a total gross profit of $45 and a gross profit margin of 45%. Now, suppose you cut the price by 15% and your unit volume stayed the same. Your sales would now drop to $85, your gross profit to $30, and your gross profit margin to 35%.

To maintain your original $45 gross profit after your price cut of 15%, you would have to increase your sales by 50%. Is it easy to increase sales by 50% in this industry? I don’t think so. Is this line of thinking forcing people to work too hard? Absolutely. This is the mathematical formula to calculate the unit volume increase required if you reduce your price, with GPM representing gross profit margin:

GPM% – 1 = Unit Volume % Change

GPM% +/- Price Change%

or

.45 – 1 = .50

(.45 – .15)

With this price-chopper scenario, you would need to sell 150 units instead of the 100 units per month you are currently selling. This is working harder rather than working smarter.

Slow down and do the math. It would most likely make more sense to invoke a price hike. If instead of lowering the price of the item, you raised it by 15%, and your unit volume stayed the same, your sales would go up to $115 and your gross profit to $60. To calculate out how much your sales would have to fall off before your gross profit in dollars would drop below the original $45, you use the same formula, but this time add, rather than subtract the price change percentage.

.45 – 1 = .25

(.45 + .15)

In other words, you were selling 100 units before the price increase, and the mathematical formula is now telling you that you could let your unit volume drop to 75 units (100 – 25 = 75) if need be, and you would end up making the same dollars by selling less.

That is working smart rather than hard.

Price cuts must generate large,

often impossibly large,

increases in unit volume

to regain lost gross profit dollars.

Working smart allows you to spend time with the client and build the relationship that is required today to secure all his business. When you are too busy because you have to move a significant volume to recover lost dollars, you do not have the time for your client. There is no way you can develop a professional business relationship on the fly. If the unit volume dropped to 80 units after the price increase, you are actually making more by selling less with the price increase. Once again I must ask, are you interested in creating activity or profitability?

By using this formula you can quickly calculate the changes you would need in sales volume to maintain the gross profit dollars after a price increase or decrease. This exercise should be a must before any service shop, or jobber, lowers his prices or has a sale.

You will see that price cuts must generate large–often impossibly large–increases in unit volume to regain lost gross profit dollars.

On the other hand, price increases can sustain large decreases in unit volume and still improve gross profits. In spite of this example, many service providers and many jobbers continue to under-price their products and services to remain “price competitive.” This is a habit and common practice with many shop owners and jobbers in financial trouble. They just don’t get it yet.

When sales are slower than you would like, it takes knowledge and creativity to turn a situation around without sacrificing margins. The main question must still be asked: who are we selling to, and what value do we bring to the table for the price we are charging?

The better business people within our industry will look to price cuts as the last resort, not the first point of attack. Do the math in your business and get off the emotional bank account. Math does not lie.

A successful entrepreneur today is motivated by the desire to achieve excellence in business quality, service, and build long lasting relationships, not by the desire to beat others on price. Reconsider your position, and truly evaluate where your company stands on this issue.

Robert (Bob) Greenwood is president and CEO of E. K. Williams & Co. (Ontario) Ltd. and Automotive Aftermarket E-Learning Centre Ltd. Bob has more than 27 years of business management experience within the automotive industry, counseling individual shops in Ontario, and has developed business management courses for the independent maintenance and service sector proven to enhance the shops’ profitability and grow the business. Bob has also worked with wholesale jobbers on how to do a better job for the service provider by providing valuable insight as to the real challenges faced by the retailer today.

E. K. Williams & Co. (Ontario) Ltd. offices specialize in the independent sector of the automotive industry, preparing analytical operating statements, personal and corporate tax return completion, business management consultation and employee development. Automotive Aftermarket E-Learning Centre Ltd. is devoted to developing automotive shop business management skills through the e-learning environment of the Internet at www.aaec.ca.

Bob can be reached by e-mail at greenwood@ekw.ca or greenwood@aaec.ca.