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Profit Parasites

Furniture World Magazine
Volume 143 NO.3 May/June


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They are rightly named “Profit Parasites”. Like thieves in the night their insatiable appetites silently steal our working capital.

Seldom do they appear in the spotlight inasmuch as they are not specified as line items on financial documents or the Chart of Accounts.

These ticking time bombs suck the life blood out of corporate entities of all sizes even though management is dedicated and exhibits leadership excellence.


Profit Parasite #1-


Time Constraints: In many instances, time constraints are key in failure to monitor all areas of the corporate complexity. While some managers may have time to focus on areas including inventory management, sales, promotion, merchandising, motivation or retention of personnel, and customer relations, other areas of importance may fall out of financial focus.

Profit Parasite #2 -


Insufficient Financial Analysis: Many money managers find that the scope and content of the balance sheet, cash flow and income statements are satisfactory expressions of financial status and progress.

These traditional financial documents, while necessary, are lacking. By themselves, financial statements may fail to reveal trends that can be discovered by using ratio analysis and internal current comparisons.

Ratios reveal and warn both positive and negative trends in a timely manner. Retailers wishing to learn more about using ratios can find an excellent treatment of this topic in the first two installments of David McMahon’s “Think Profit” series posted to Furniture World’s website at www.furninfo.com/ series/thinkprofit.

Profit Parasite #3-


Discounting: Discounting can increase traffic and sales, but can also be a major profit parasite. And, when applied injudiciously, as in the case of unbelievably large discounts, it can have a negative impact on retail credibility. “Why, sometimes I've believed as many as six impossible things before breakfast." says Alice in Lewis Carrol’s “Alice's Adventures in Wonderland.” There is, however, a limit to what customers can be expected to believe. Care should be taken, therefore, with regard to preserving credibility at every retail touch point. When a retailer loses credibility in one area – it may be lost in all areas.

There is a time and place for discounts. The question is when and how are they administered.
In our desire to increase revenues through discounting, whether during daily sales or periodic promotions, we need to give thoughtful consideration to the dollar amounts required to maintain the same gross profit.

Even small discounts can have significant implications. For example, When you discount 10%...
  • if your gross profit is 40%, you must sell 33% more $$ to break even. 
  • if your gross profit is 43%, you must sell 30% more $$ to break even. 
  • if your gross profit is 46%, you must sell 27% more $$ to break even. 
  • if your gross profit is 49%, you must sell 25% more $$ to break even. 
The lower the gross margin, the greater percentage must be sold to break even.

Most consumers are aware that when they purchase a product or service based primarily on price, they may be pleased on the particular day that the sales transaction is consummated. But, when price takes precedence over quality and value they may regret their decision to opt for price over quality, beauty, pride and performance during the entire life of the product.

Customers that become dissatisfied with quality, seldom become repeat customers. And, successful businesses are built on repeat sales. Loyal customers reduce the investment of promotion dollars required to generate repeat sales.

Quality then has the potential to replace low price as a centerpiece of the consumer concern.
Retailers can enhance this potential by encouraging salespeople to present unique features and have knowledge of competitive products, so they can establish the relative value of products under consideration.

The more detail that is made available to our customers both verbally and visually, the less reliance needs to be placed on price and discounts to close the sale.

In some instances, customers shop with a fixed price in mind because they have seen products or groupings of a similar nature advertised at a reduced or discounted price with little knowledge of the type of material, construction, quality or beauty.

Psychologists refer to this mental methodology as “anchoring”.

Responding to price objections with “automatic adjustments” undermines margins. So, instead of donning an attitude of resignation, come up with a plan to preempt price objections or interpret objections as implied needs and respond with the application of intelligent selling skills. Resist the temptation to mimic the competition, especially if their continuous promotion policies are leading you down the road to ruin.

Here is one last note on the discounting profit parasite. When it is necessary to provide concessions to close a sale, offering terms may prove more profitable than discounts of 10% or more.

Intelligent Furniture Discounting


How do you determine the formula to select the size of the discounts required to insure customers will travel to your store to take advantage of your promotion.

Is the catalyst for action predicated on customer need? Does distance to travel to the store correlate to the size of the proffered discount? Will discounts of 70% attract significantly more than 40 to 60%?
At which point do astute managers sacrifice profits for revenues?

These challenges may be ruled by geographical area, the economy, the season, competition, relocation or changing technology.

Even prudent management requires continuous assessment. Factors and specifics vary from one selling season to another. Generally though, the following rules are worthy of review:

Rule A: Having rigid rules for mark-ups are not a prudent retail business practice.

Rule B: Price points are critical in closing a sale. A $588 price “fits” into a more acceptable zone than one that is listed at $612. Rounding off invites and encourages positive response at point of purchase.

Rule C: A better ratio for evaluating the meaningful management of price points is to factor Turns X Gross Profit Dollars rather than evaluating inventory turns and gross profit as separate and meaningful financial formulas.

A Gross Profit of $400 X 5 Turns resulting in a gross profit/turn ratio of $2,000 is perhaps more satisfactory than Gross Profit of $440 (up 10%) X 4 turns resulting in a gross profit/turn ratio of $1,760.

Many management principles lead to success. Some suggest the rate of turnover is the most important factor in business.

Not only is the return on investment increased through increased sales but cash velocity is expedited as well. Turning our money every 75 days rather than every 90 days has significant ramifications in meeting obligations to our suppliers, lending institutions and cash flow.

Profit Parasite #4-

Excessive Inventory: The two largest blocks of working capital, inventory and receivables, are vulnerable to abuse by the Profit Parasites.

Some business consultants suggest that the 3rd major reason that businesses fail is the inability of management to understand and respond to the changing market.

Each year we are encouraged to add new updated items to stay-in-step with the emerging market trends. Frequently, as we add new items to our product offerings on the showroom floor, we fail to rid our inventory of a proportionate dollar amount of items that are “past their prime”.

The Pareto/Jung theory suggests that 20% of our products or services account for 80% of our sales generated.

It is not unusual to annually increase new items to our inventory 10 to 15%. The counter-productive result is that while sales increase, inventory turns decrease, leaving working capital to stagnate.

Simultaneously, increasing turns and revenues without discounting as a means of promoting revenues is a blue ribbon sign of meticulous and meritorious management.

Proponents of supply chain management suggest that the cost of carrying inventory exceeds double digits annually. This determination is based on cost of interest, obsolescence markdowns, shrinkage, shelf or floor space, insurance and tracking time.

Too much inventory is just as costly as insufficient inventory. Bloated inventories become liabilities rather than assets reflected on the balance sheet.

SKU’s that do not produce or help close a sale every 75 to 90 days on an annual basis should be given thoughtful consideration as a standard item of floor merchandising.

In evaluating the decisions of management to reduce margins, it is just as critical that we judge intent as we judge results. Is the intent of discounting to boost sales through reduction of price and margins? Or is it to reduce your offerings of dated products and return that investment into working capital for new, fresh goods that are in step with current, popular trends?

Profit Parasite #5-


Failure To Take Purchase Discounts: Failing to exercise the opportunity to take discounts from vendors can have significant implications.

While many in purchasing positions advocate buying in increased quantities, to qualify for discounts, astute money managers consider the value of taking advantage of discounts. Buyers that exercise this opportunity realize that:
  • 1% 10 days – Net 30 days is equivalent to 18% per annum.
  • 2% 10 days – Net 30 day is equivalent to 36% per annum.
  • 3% 10 days – Net 30 days is equivalent to 54% per annum.

Profit Parasite #6-


Failure To Control Receivables: While controlling inventories involves managing the largest block of working capital, the second largest area relating to working capital is receivables.
Managing credit and payment delinquency is paramount to profitability.
It is the norm to list Goodwill as an asset and we are cautious about losing it when we enforce credit and collection policies. But it is a necessity that requires constant vigil. Psychologists advise that we frequently make the mistake of thinking of ourselves as exceptions and trusting stories over statistics. However, the U.S. Department of Commerce has promulgated the recovery rate of receivables to be:
  • 96% at 30 days.
  • 90% at 60 days.
  • 83% at 90 days.
Billing credit customers with expediency and regularly is not a choice but a necessity. This is an area where hiring outside resources may be more productive than our own efforts to protect Goodwill. Until and unless we monitor credit and collections with discipline, they can evolve into Profit Parasites of monumental magnitude.

Profit Parasite #7-


Doing Too Little, Too Late: Frequently when we identify negative trends and the need for corrective action, we opt for the “Band-Aid” method of management.

We patch up the “hole in the dike” hoping it will heal the affliction with minimal investment of time and corrective treatment. Too often our response for remediation is too little, too late.

Emily Dickenson’s admonition “if we take care of small things, the big things will take care of themselves” is as valid in modern American retail furniture business affairs today as it was during the early 1800’s.

CONCLUSION

No organization is guilty of all business management misdemeanors. But few are not guilty of some.
When is the appropriate time to address these Profit Parasites? With increasing competition, a stand-still economy and the trend toward internet activities, management by procrastination is seldom beneficial and is often detrimental. There is no more important time to review and remediate these Profit Parasites than now.

Ray Morefield has been affiliated with leading corporations in the housewares, hardware and coatings industries. He has also served other industries in an advisory capacity through Common Goals, Inc. Questions or comments can be sent to him by emailing editor@furninfo.com.


Read other articles by Ray Morefield