Showroom Gross Profit Margins Are Too Low!
As I indicated in last month's article, I have been working with a number of wholesalers and their showrooms in the past several months. Each of these wholesalers has recognized the tremendous potential that showrooms offer. All of them are spending a lot of money redoing, updating and expanding their showrooms. All have multiple showrooms and have made a commitment to diversify the products they're showing and selling. All of the showrooms are located in the wholesale facility.
The one area that jumped out and concerns me the most is the very low gross profit margin on sales. Most were in the 23% - 28% range. One is fringing on 30%. The attitude seemed to be “Hey, the showroom margin is two to five points better than the wholesale side - so we think we're doing pretty good.” This writer believes these margins stink! They're much lower than they should be to justify the investment, time and energy put into a showroom.
Let's face it! The showroom business is a higher cost operation. You have smaller sales per employee, displays that are expensive to build out and the display product just sits there looking pretty! No “turn and earn” there. Rent and utilities are higher, and 75% of all product sold is special order, which creates more shipping and receiving costs and more paperwork.
Only two of the wholesalers treated the showroom as a profit center. That means that only two of these businesses knew whether they were making money. The owners invested a quarter of a million in building out each showroom, and they don't know if they're making money? I don't get it! I'll bet if the owners had invested the same amount in Wall Street, they'd be checking the stock market every day to see how their investment was doing.
I want to focus on that very important line on the profit and loss statement: gross profit in both percentage and dollars.
Let's start with the basics. This article isn't just for the bosses - it's for everyone. You have to understand what gross profit margin is and how it's derived. You have to understand that making money and losing money depend a whole lot on the gross profit margin.
The very first line on an operating statement (or profit and loss statement) is sales revenues. The second line is cost of goods sold (what you paid your vendors for the products you bought from them). The third line is gross profit margin. It looks like this:
Profit and Loss Statement
Month: September - Year: 2006
Sales Revenues $500,000
Cost of Goods Sold $375,000
Gross Profit Dollars $125,000
Gross Profit % 25%
Next you deduct all the expenses related to the showroom operation, and this gives you an operating profit or loss figure. Take out taxes, and you have the all-important “bottom line” or net profit. Note that gross profit and net profit are two very different lines on the profit and loss statement. Gross profit tells you what you made on the sale. Net profit tells you how much you made running the business.
Understanding how to calculate a gross profit percent is very important. Assume you want to make 40% (the percent I believe every showroom should average) on the sale. Assume also that your cost of goods sold is $10,000. You DON'T multiply 1.40 x $10,000 cost of materials, because this would give you a selling price of $14,000 and a gross profit percent of 28.57%.
You DO start with 1.00 and subtract the percent you want to make, which is .40. For example:
1.00 - .40 = .60
You then divide the cost number, which is $10,000, by the .60.
$10,000 ÷ .60 = $16,666.67
This is the selling number. Always use this formula when working from cost.
Most showrooms do a discount off the manufacturer list price. This is fine, but you have to know the cost factor in order to hit whatever your gross profit goal might be. Let's stick with the target that I believe all showrooms should strive for: 40%.
If your cost multiplier off list is .50, then you can only discount off list price 16.7% to achieve the 40% gross profit. If your multiplier is .45, you can only discount off the list 25% to achieve that same 40% gross profit. If your multiplier is .40, you can only discount off list 33.3% to achieve that same 40%. Please be sure you understand this, or you'll never be able to improve your margins.
Another quick way to determine the gross profit percent is to subtract the cost figure from the selling price; this gives you the gross profit dollars on the sale. Then divide that number by the sales number. Here's an example:
List Price of the Sale $10,000
Discount off List 25%
Net Selling Price $750
Cost of Goods Sold $450
Gross Profit Dollars $300
Gross Profit Percent 40%
(GP $300 divided by the selling price of $750)
Okay, that's it for Class 101 on how to figure margins. Now let's talk about some ways to grow the margins you're generating today.
- Reduce the discount off list price. Start with just one or two percent. (If your discount is list less 35% now, change it today to make it list less 33%).
- Don't get stuck in the 5's syndrome. For example: List less 40%, 35%, 30%, 25%, etc. Mix it up! Odd numbers are okay: List less 37%, 36.5%, 29%, and 21.5%, etc. Pick up 1%, 2%, or even 4% wherever possible.
- Don't use the same “across the board” discount for the same manufacturer. If there are a number of Kohler or American Standard items on the quote, don't do a flat 40% or 35% off list price. Sure, the popular items that everyone checks have to be competitive, but why would you do these deep discounts on bath accessories - in fact, on any accessories, such as strainers, waste and overflows, angle stops, flex lines, box flanges, cutting boards, etc.?
- Have a diversified display of products. DON'T only show and sell the traditional wholesale products (Kohler, American Standard, Delta, Moen, Grohe, Elkay, etc.). Have some nice decorative lines that not everyone in your region has and that you buy with a nice deep discount.
- Learn to sell the “add-ons” - and sell them at better margins. Don't just sell the kitchen sink. Sell your favorite faucet (the one you make the most money on), and fill up all the holes in the sink with a soap dispenser, water filter, instant hot, chiller, disposer air button, etc. And always sell the best strainer. Your client will appreciate it! Give them quality! Don't let the plumber get away with installing a cheap Taiwan strainer that you sell to him by the dozens over the counter.
- Now here's the biggest and best suggestion of all: Don't sell the plumber at the same discount they get on the commodity products over the counter or out the warehouse door! The discount has to be different on ALL showroom orders. Remember, the cost of operating the showroom is higher than the wholesale side! That means you have to make more on your showroom sales. Yes, it does! Wholesale indicates volume and dictates lower margins. But when running a showroom business, you have to put that deep discount mentality aside. Start thinking retail and higher margins!
Okay, you say, “We can't do different discounts to the plumber through the showroom. They won't let us.” Well, who the heck is running your business - the plumber or you?
Here's what I've done with a number of my wholesale consulting clients:
- We identified the main showroom plumbers.
- We sat with them one at a time. This is very important.
- In our meeting we explained that we weren't making enough margin on showroom sales to justify doing the showrooms. We would have to change the discount off list on showroom orders, or we'd have to close the showroom. It takes real commitment to do this, and if you're going to say it, you have to mean it!
- We then did a numbers exercise that showed the plumbers that they can actually make more money even when the discount isn't as deep. It goes like this: Just for the purpose of this exercise, let's assume the plumber wants to put a markup of 15% on the cost of products.
OLD Discount Structure:
Total List Price on this Order $20,000
Old Plumber Discount Off List 40%
Old Net Price on this Order $12,000
15% Markup to the Customer $1,800
NEW Discount Structure:
Total List Price on this Order $20,000
NEW Plumber Discount Off List 35%
NEW Net Price on this Order $13,000
15% Markup to the Customer $1,950
The plumber just made $150 more! And this was with a small discount off list price. And you just improved your gross profit margin by 5.76%. BIG!
Sure, you have to keep the plumber competitive in the market place - and yes, you have to provide a full plate of value through the showroom.
Here's a question for you. Assume your selling price on the finish plumbing products of a very nice house is $20,000. If you've done a great job selling value throughout the process, what would happen if your selling price had been just 1% higher? That 1% is a mere $200 dollars. I'll bet you anything that you'd still get the order! So here's your prize for reading this article. Raise your margins by ONE FULL POINT - today! You won't lose any sales and you will have improved your pretty weak margins by one full point. You'll see how easy it is - and in three to six months you might want to try it again. Good luck and enjoy those extra dollars on the bottom line!