Use these variable cost techniques to maximize your results.
Profitable Operations by David McMahon
Wouldn’t it be nice to always have an 8% net income? When the economy and resulting sales are booming, an 8% take home at the end of the day is very good. If things slow down, and you can hold 8%, or get back to it quickly, that is fantastic! When things turn around you will probably even surpass that 8%.
It is true that most furniture retailers will never reach this level of profitability, however, others seem to always manage to perform well. In this article we will take a closer look at what those successful retailers do to cut costs during lean times and achieve maximum returns.
Many average businesses over the past couple of years were dragged down by high fixed costs. As soon as the economy entered into recession, profits fell and cash flows slowed. These businesses were not able to reduce fixed costs fast enough, causing many to borrow from assets and others to go out of business.
On the other hand, those who had a larger percentage of variable costs tied directly to sales performance, and companies that adjusted fixed costs fast, saw more stable profit levels. They are in a position now, at the start of the recovery, to reap the benefits and edge out competitors that were forced into the red zone by the recession.
The recovery could well be a bumpy road up the mountain, but there is still time left to realign costs so that you are certain to maximize your profit potential. Here are the areas to focus on:
Adjusting the way you pay salespeople is one of the easiest ways to keep costs under control. Some may argue that there are valid team-building and customer service reasons for paying sales associates salaries as opposed to straight commissions, but in tough times, salaries are hard to reduce. Likewise, reducing sales staffing levels for full time employees is a blunt instrument and one that normally proceeds slower than business conditions require.
Commission rates vary with sales levels so you want to do everything you can to keep salespeople motivated and their commissions rising. One excellent system you might consider for raising commissions, sales and overall gross margins is to vary your commission rate with your gross margin percentage achieved on the sale of each item. For example, if your average gross margin is 45% and you already pay a straight commission of 6%, you might change to a variable rate by setting a high commission rate of 8% that corresponds to a high gross margin of 55%. And at the opposite end you might set a low gross margin percent of 30% that corresponds to a low commission of 3%. Any sales in the middle of this gross margin range are paid at a rate of 3 to 8%. So, if a sales associate sells a home theater at 45% gross margin, she would receive a 6% commission. However, if she sold the dining set at 55%, she would get 8%. On the second item you would give an extra 2% and gain an extra 8%. It works the other way too, of course. Companies that have implemented this type of variable sliding system in an intelligent way have experienced jumps in gross margin and sales improvement.
Inventory and Cost of Goods
Inventory is really an expense disguised as an asset. Slow or non-moving inventory is worse because it is stagnant, producing significant carrying costs. Care should be taken to watch and control your percentage inventory to sales. The sweet spot for inventory to sales is 15-18%. On the cost of goods side (the cost of inventory after the sale), 55% or under should be your target, so you can maintain a high profit margin of 45% or above. The exception to this rule will be if your operation generates more than $10 million in sales and maintains a “high turns, low price” strategy. Top companies maintain their margins in all economic times. You can do this too, provided you do not become over-inventoried, and need to run huge clearance sales that kill gross margin. A few keys to maintaining decent cost of goods and gross margin rates are:
- Keep inventory to sales at 15-18% by controlling new buying.
- Reorder best sellers at the right time in the right quantity.
- Price best sellers and special order at least 5% margin points above overall target.
- Have a mark down strategy that marks down in smaller percentage steps sooner to maximize turns and gross margin.
Administration costs cover a whole host of items such as office and management salaries and benefits, computers, professional fees, travel and entertainment, and the list goes on. Administration has both fixed and variable components. In a downturn it is important to watch for rising administrative expenses as a percent of sales even if they are, in part, due to declining sales. If sales fall for two or three months in a row, look at the detail in this area to identify expense items that don’t add value to your business.
An alternative approach to controlling cost here is to give administrative personnel more control over expenses and provide pay or bonus incentives for cost cutting measures that help their department to come in under-budget, especially during lean times.
I’ve seen some creative solutions in occupancy in the past two years. It really depends on your individual situation, but in general there are two possibilities for getting this typically fixed expense somewhat variable:
- If you own your own building and are paying rent to yourself, set a variable occupancy rate based on sales, 7% for example. Thus, you take more out as a dollar amount in good times and less when sales are poor. That way your business is always on budget.
- If you rent from someone else, renegotiate adjusted levels based on new lease rates. Some landlords will even agree to variable rates based on sales.
It is not an acceptable option to pay occupancy rates in excess of 10% unless walk-in traffic at your location is so good that you can reduce marketing budgets to offset the added expense. In most areas 5-8% of sales are reasonable.
A client told me at market that he heard someone say, “The game is played with merchandise but won with marketing”. That is true, but when times are tough we need to market smarter. The best marketing, and also the most underrated marketing, is customer follow up. Marketing today is about helping customers find you and building relationships for the long term. The days are gone when furniture retailers could survive by just generating the most traffic, selling customers immediately and then forgetting about them. You need traffic now, but you should get it by focusing on methods that produce the highest return on investment for the money that you put out there. The most productive methods to do this are webpage leads, e-mails with highly targeted messages, and individual follow-up by salespeople in the form of e-mails or calls. These produce new traffic and be-backs with little cost involved. Many retailers are finding that their media practices of the past are producing fewer leads. Start changing your marketing mix, otherwise total costs as a percentage of sales will continue to drift up.
Many retailers are finding that their warehousing and delivery operations need to be partially offset by delivery charges. Some companies are able to offset all of their fixed and variable delivery expenses in this way.
If you are not charging appropriately for delivery, you are really just paying for it out of your gross margin dollars and your warehouse team is probably looking overly expensive. Many businesses have been able to reset their delivery and set-up service to a more appropriate rate without a single hint of an effect on sales. A free delivery policy is not a good selling strategy. If you add this cost into your selling price, you will appear to be more expensive than your competitors. This will be especially true in areas of the country where many customers pick up furniture with their own trucks.
Re-evaluate how you compensate delivery teams, staff properly and install efficient systems. In this economic environment, a number of furniture retailers have improved their level of delivery performance and customer service by paying delivery teams by the stop or piece rather than the time. A distribution operation that is laid out properly with good systems and procedures, has the proper equipment with the correct number of people, and is bar coded should run consistently at under 4% of sales after delivery is netted out.
When times are tough your customer service people need to be especially good. Great customer service managers minimize the cost of service and maximize credit revenue as it goes up and down with sales. They are also highly organized; ensure proper preparation of merchandise and pursue vendor credits and customer charges where justified. In the best operations, customer service centers turn into profit centers.
Outside of loan interest, expenses in this category are largely variable. Finance company and credit card fees are incurred when sales are made. The key is to minimize these expenses. Make sure that you get the best rates either directly or by joining associations such as HFIA, WHFA or NHFA. Retailers have used a number of strategies with finance companies to successfully minimize this variable cost. These include offering only the lowest cost programs; having a separate finance only price; charging financing processing fees; and reducing your reliance on financing as an advertising and selling vehicle.
It is by mandating profitability that great businesses keep their profitability high throughout boom and bust times. You can’t control the economy, but you can control the fixed and variable aspects of your core expense categories.
David McMahon is Director of e-Strategy and a business coach for PROFITconsulting. PROFITconsulting is a full service consultancy and marketing agency that specializes in retail furniture. FURNITURE WORLD Magazine readers can contact David to discuss this and other operations and marketing topics at firstname.lastname@example.org or call him direct at 800-888-5565. Read more of David McMahon’s articles on furninfo.com.