As a distributor, you have limited resources available to service your customer base. Inventory management is critical, cash flow management is critical, cost containment is critical, and a definitive pricing strategy can be your "edge" in creating competitive advantage.
If your organization is not skilled in activity-based cost analysis, you might try to determine your most profitable customers using a simpler approach. This approach uses basic calculations to give you some sense of where your money comes from and where it goes.
Most of your cash is tied up in inventory and accounts receivable. Consequently, you need to be disciplined enough to ration your cash investments to only those customers who provide a return.
The following steps describe a simple calculation that can provide answers without using an all-out activity-based cost analysis:
1. Determine the average cost of processing an order in your business.
What is your cost to process an order, pack it, ship it and collect payment? Each of these stages has internal costs that you assume are covered in your pricing matrix schemes. For most distributors, the cost to process one order completely is between $30 - $100 per order.
2. Determine key figures for each customer.
- Total sales
- Total cost of goods sold (COGS)
- Gross margin dollars (item 1 minus item 2)
- Number of orders processed per period
Multiply the number of orders by your estimated cost to process an order. You can use the specific number you calculated in the first step above, or an average provided by your industry association. This cost can change drastically based on the type of product sold and the services provided with each order. However, the $50 range would be a good place to start.
Determine the net profit for each customer. Now that you have multiplied the number of orders by the per-order cost, subtract that cost from the gross-margin dollar figure. Do this for each customer. The result will be either a positive or negative number.
List the results. List your customers in descending order, from the largest contributor of net profit to the lowest contributor. (You will hit the negative numbers quicker than you might imagine.)
Not surprisingly, the Paretto Rule often applies here. You may get to zero and negative contribution after about 20% of your customers have been analyzed. It is this remaining 80% that have some negative impact on your bottom-line profits. Eliminating 80% of your customers based on this exercise is not realistic. However, you certainly might want to analyze how you are doing business with them.
Dr. Rick Johnson is a keynote speaker at PBA's upcoming Distribution & Sales Summit. Learn more about Johnson's participation in the Distribution & Sales Summit in the next article. To read the rest of, "Profit Is NOT a Dirty Word," visit www.ceostrategist.com and click on "Articles by Rick."