By: Greg Pulitano, CPA
As manufacturing and distribution companies grow in size and complexity, a common problem that business owners face is increasingly unpredictable and uncontrollable profit margins. What once was a fairly simple and straightforward facet of their business has gradually come to involve so many different factors that owners often feel like they no longer have a clear picture of what their profit margins are, let alone a solid handle on controlling them.
The initial step to controlling profit margins is recognizing the practical aspects of your business that can be analyzed and handled on a manageable scale. Identification and management of many specific, independent parts of your business can add up to big savings, increased control, and higher profit margins. Many problems can be solved by taking a close look at four aspects of your operations: product line performance, logistics, returns, and sales or account representatives.
First, analyze your sales by individual product line. Analyze each line individually to determine actual profitability. Which lines contribute the most profit? Which lines are underperforming? Are certain lines running at a loss? Once you narrow your frame of reference to your “problem products,” you can then formulate strategies to increase margins. Once you have this data, you will need to determine whether your low margins are a result of increased production or product cost, or low pricing. In order to expand profit margins on your various product lines, you may look to improve your sourcing for either raw materials or product. You should continuously shop for the most competitive pricing without sacrificing quality. Likewise, when deciding how to price your products, you should frequently test the market by increasing your prices slightly above the levels that your sales force believes they should be set at. If this results in lost sales because your prices are too high, then you should re-set your prices. You may, however, find that you have some wiggle room to increase your prices for certain specialty items, thereby giving your profit margins a boost.
Secondly, there are tremendous potential savings to be found in a review of your logistics management. Improper management of the administrative end of the warehousing and shipping process can be very costly. If your business model revolves around direct shipping, an outsourced warehousing solution could potentially save you significant amounts of money. However, if a large portion of your business requires you to carry inventory for periods of time, an in-house solution might be more appropriate. You should prepare a cost benefit analysis to see if the cost to manage your warehouse activity internally is significantly higher or lower than third-party solutions. If you do manage this internally, your operations are probably spending time on customs paperwork, reconciling bills and shipping documents, or re-inputting order entry data. You should take these costs into account when you prepare your cost benefit analysis; you may be able to cut costs and improve efficiencies by changing the way you store your inventory.
Shipping is another piece of logistics that should be analyzed. Using a knowledgeable freight forwarder can make a tremendous difference. There are two primary things you want to look for in a freight forwarder: effective consolidation and product specialization. A good forwarder can help you manage your shipping costs and help you get the most efficient and effective shipping for smaller, more costly shipments. Freight forwarders frequently have strong contacts within the shipping industry and are often privy to options not readily available to all businesses. Their knowledge of the industry allows them to identify vessels that have room for additional freight. This often lets the customer take advantage of certain discounts, since the vessel is still going to the port in question.
Thirdly, take a close look at your returns. You can analyze your returns through two
lenses: customer trends and product line trends. The first will provide a clear picture of who your “problem clients” are. If you have a customer who is consistently returning products, then you may want to revisit the relationship, as it may not make financial sense to continue to sell to them. Another way to analyze your returns is by product line. This analysis might provide you with data on what products are problematic. Returns cost your company money: recording the return, issuing the customer a credit and restocking the inventory. The key to minimizing returns is to listen to what your customers are telling you and adapt accordingly. Speak with your customers often to find out if a product is inferior or has a flawed design. A comprehensive analysis of returns can help you identify the issues that are costing you in terms of time and lost profits.
Last of all, consider how you’re utilizing your sales force and manufacturing reps. How are they compensated? Are their commission based on profit margins or on sales dollars? Are they compensated for sales that are not realized and collected? Are you relying solely on them to determine your customer needs? This could be a problematic way to look at the market, as their interests might ultimately be different from yours. Also, consider whether or not you have the right reps to service the markets that you sell to. A little bit of shuffling in a stagnant, content sales force can give your profits a healthy kick-start.
When considering ways to get control of and increase your profit margins, it is highly advisable that you take a comprehensive look at your operations. Using a few of these techniques may give you clearer pictures of individual aspects of your business, but when taken in totality, you can gain clearer knowledge of your operations, more control over your profit margins, and increased peace of mind. Speak with your business advisor about ways to take back control of your business.