Understanding Gross Profit Margin
I’m very seldom late in getting these columns to my editor… but this month is an exception. I’m doing a bicycle ride from Portland, Maine, to Daytona Beach, Fla. We (25 of us) left Portland on Sept. 21, following the Atlantic Coast as much as possible and riding approximately 85 miles a day - rain or shine. Speaking of rain, we’ve ridden 16 days so far and 12 of them have been in the rain!
I assure you this is all for a great cause. This 1,600-mile ride is in support of the Decorative Plumbing and Hardware Association Scholarship Fund. My wife, Carol, and I, along with some other industry folks started this fund five years ago. In 2009, I rode my bike from Los Angeles to Boston (3,600 miles and more than a million pedals). I was honored, pleased and overwhelmed to raise $27,500 for the scholarship fund on that ride. At the last tabulation I think this year’s donations were more than $15,000. You folks are terrific.
On Oct. 15, the DPHA will announce two $3,000 scholarship winners. If you haven’t made a donation and would like to, please go to www.dpha.net to learn how to participate. Yours truly will appreciate it very much, as will our scholarship winners.
One of the many manufacturers that donated to my ride is Mr. Steam - the folks that make those terrific steam generators. They asked if I would visit a couple of showrooms during my ride and I was pleased to do it. So, after our day’s ride to Savannah, Ga., I got the chance to visit two of Mr. Steam’s local showrooms: Coastal Bath and Kitchen, owned and operated by the Wells’ family, and Sandpiper Supply, owned by the Howard family. Both had very nice showrooms and were gracious to make a donation to the scholarship fund as well as have some pictures taken. My big thanks to both of those fine companies.
While at Sandpiper I mentioned I had an article due and had a case of writer’s block. They were very kind on their comments about my columns and suggested that a follow-up article reinforcing gross profit margin might be good. Sandpiper is a plumbing wholesaler and does a big counter trade. They acknowledged that not all their folks in the showroom or selling at the counter fully understand the impact of “cutting the price” to get the order. They might end up allowing the contractor to talk them into lowering the price because they can buy it cheaper down the road. Unfortunately, very seldom is there any consideration given to the quality of products or services.
The Howard family suggested another column on gross profit margin that they could use to help educate ALL their employees on this very important subject. These folks have built a very nice business in the 34 years they have been in existence and I believe very strongly there will always be a niche for well-run, small, family-owned wholesalers.
I had the privilege of knowing Charlie Horton, the founder and longtime owner/editor of Supply House Times. Way back in the 1960s, he got frustrated by wholesalers who were too quick to cut the price or who really didn’t understand mark-up and mark-down. He wrote a scathing editorial on the subject and included a detailed chart that showed how much you have to add to cost to make “X” of a GP margin.
Chat Howard Sr. at Sandpiper had a copy of this very chart under a glass top on his desk. I have a copy at home. If you would like a copy, email me and I’ll send it along.
Here’s a brief example of what it shows:
The chart I refer to above breaks this down to 1% increments.
If you want to make You have to ADD this % to the
this GP Margin: cost of the product being sold:
Let’s go back to the beginning and explain the definition of Gross Profit Margin. It is the difference between the selling price of a product and the actual cost of that product from the manufacturer.
Here’s an example:
You sell a faucet for $200
The cost from the Mfr is $150
Your GP Margin $ are $50
Your GP Margin % is 25%
GP Margin of $50 divided by the
selling price of $200
Here’s an example of how mark-up works:
Your cost on the above faucet is $150
You want to make 33% instead of the 25% shown above.
Subtract .33% from 100% = 67%
Divide the cost of $150 by the 67%
The new selling price would be $223.88
Or get a copy of the chart referred to above and use it!
Most employees, and I’m afraid even some owners and managers, don’t fully understand the huge impact that “cutting the price” by 1%, 2% or 5% can make on the bottom line and vice-versa.
Using the same faucet example: You set the sell price on that faucet at $223.88. Your customer talks you into a 5% discount. The new selling price would be $212.69. The new GP Margin percentage would be 29.5%. In order to make up the price cut of 5% or $11.19, you will have to sell $37.93 more product at the new cut price margin of 29.5%. This is huge and very difficult to do.
I apologize for being just a tad technical in these examples, but the strong message is that just cutting the price a little can make a huge impact on the bottom line.
Let’s say you’re a showroom sales consultant and you’ve just spent four hours working with Mr. and Mrs. Gotrocks on a big bathroom remodel. If you’ve done a good job selling yourself, your company, your products and services, I believe you should be able to add one, two or three points to that quote. The Gotrocks will most likely not want to go anywhere else because they liked everything they’ve seen and heard. Unfortunately, most salespeople have a fear of losing the order, so they will lower the price in order to get the sale. This is not a good thing.
Have confidence in your total value package. Reward yourself and your company by making as much as possible on each and every order. I’ve talked about that “total value package” several times in the past. Take a moment and look it up and put it to work for you.
I believe all folks involved in the selling process including showroom people, counter sales, outside sales and, of course, all managers should be educated on this very important subject. Show them examples like I’ve tried to do. Build incentives on compensation that will impact their earnings. Have a monthly report card for everyone reflecting what their sales and GP margins were.
Every single percentage point you give away or add to the price affects your job security. Take this subject very seriously and be GP Margin conscious on every sale.