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A Recipe For Maximum Gross Margin

Furniture World Magazine
Volume 146 NO.4 July/August


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There are ten major ingredients in this tasty recipe that you can use to maximize your gross margin.

The Ingredients

1. Belief and Commitment
2. Custom Order Pricing
3. Standard Pricing
4. Exception Pricing
5. Markdown Pricing
6. Add-on Selling
7. Packaging
8. Discount Selling
9. Finance Pricing
10. Upping the bar

Using only one of the above ingredients in the recipe that’s outlined in this article may produce a tasty treat, but using ALL the ingredients properly implemented and integrated will produce what furniture store owners desire: A strong top line where the stage is set for profit, stability, and growth. Without strong margins, a greater amount of sales volume and lesser operational expenses are required for similar results. For most businesses with under 20 million in sales per store, it is much more advantageous to follow a high margin strategy. This keeps break-even sales volume low, allows for the necessary investment to fuel growth, pay people properly, and produce a nice bottom line for stakeholders. With this in mind, here’s the 10 part recipe that many retail masters use.

#1 Belief and Commitment

Margin is in your mind. We are not selling commodities here. There are some retailers getting 55% - 60% margins. There are some that get between 45%-50%. And some that are even higher and lower. They are ALL in competitive markets. They ALL have to compete against low-ballers and companies on the internet of questionable profitability. They ALL have dirty-window shops in their area who undercut them. Please DO NOT act like a dirty-window shop!

You must truly believe that you can get the margins you desire. Then you must commit to doing it every day, for the life of your business. Without the captain of your ship on board with this business requirement, it will be impossible to get the crew producing. Believe and commit to what you deserve and what is obtainable.

#2 Custom Order Pricing

Special orders present a big opportunity for justifiably decent margins. Selling custom made products takes much more time for all parties involved – the customer, the retailer and the suppliers, than selling stocking items. The sales process is longer due to selecting all the desired specs. The ordering process is more involved due to having to communicate the information exactly in a manner that the vendors accept. There is required order processing, acknowledgment, customer and vendor follow-up, and increased lead times in most cases. This extra work requires a decent gross margin. In my opinion, all special order vendors should be marked up at a MINIMUM of 2.2 over landed cost or a greater amount if marking up over raw cost (PO cost). It is also a good practice to vary the pricing by vendor. However keep it easy and quick for your sales people to price out orders for their customers. You don’t want them to get bogged down with complicated formulas.

#3 Standard Pricing

Standard pricing is defined here as where you start your pricing for new merchandise and for best sellers. From my experience, wherever a retailer starts their pricing they will end up about 5% of margin points lower on their financial statements due to inevitable sales and markdowns. With this in mind, pad your margins by this amount so you are more likely to hit your target. Those retailers with over inventory situations often end up even lower because they are generally forced to take bigger cuts to move slow turning merchandise. So, with standard pricing, decide on a general multiplier either over landed or raw cost. If your goal is to achieve a 52% gross margin on your P&L, you should set your gross margin at 57% for your best sellers. A standard price multiplier calculation can be found in the red box below.

In this example when setting up standard multipliers on your categories, you would use a 2.33 Multiplier over landed cost. (Note: if your software system figures multipliers over raw cost rather than landed, you would set a higher multiplier to account for freight).

#4 Exception Pricing

There are always exceptions! In this recipe for achieving maximum margins, fine tuning your pricing based on exceptions is an important step. Here are some pointers on how to approach this:

  • Figure out which vendors and categories are different from the standard due to factors such as freight rates, quality of product, exclusivity, contracts, or demand.
  • Make exception multipliers, either higher or lower, and place them on certain vendors or categories to override the standard.
  • Track bestselling items and review their price consistently.
  • Track the retail price points of your new and bestselling SKU’s within your line-up.
  • Ensure the retail price of individual bestsellers and new items makes sense within your line-up and move the price up or down when necessary.

This pricing by exception ingredient for success is often skipped by average margin retailers as it does take time and effort. Though, from what I have seen, all top margin producers are constantly reviewing and adjusting retail price when the situation dictates. Keep your finger on the pulse.

#5 Markdown Pricing

The reality is that the minority of products produce the majority of margin dollars. Items that don’t produce margin dollars are considered “dog” product. To produce maximal margin for the business overall, an effective markdown plan must be a part of regular business operations. The key is to single-out slow turning SKU’s quickly and then take appropriate action. At first, say in 60 days, if an item does not sell, perhaps remerchandise it. Or, if it was merchandised well, start marking down the retail price by say 10%. If it is still not turning in another 60 days, mark it down by a further 10%. Keep repeating this process until the item is gone. This step approach serves to turn merchandise faster and achieve a higher margin while doing so.

The amount and the time of mark down will vary depending on the strategy of the individual retailer. What is true of all good retailers though is that they have systematized and well-managed procedures to cut their losses on dog merchandise. This in turn allows for the faster testing of new merchandise. It increases the odds of producing more best-selling SKU’s and high margins.

#6 Add-on Selling

Add-ons produce higher gross margin per ticket. For this reason, I strongly recommend that you track add-on sales. These will be products such as warranty, fabric-protection, accessories, lamps, rugs, adjustable bases, sheets, and pillows. For example, if you can increase the percentage of warranty sales to total sales, your overall margin will increase due to the high margins selling these plans provide. Commit to continual employee training and include the presenting of add-on products and services in your selling system.

#7 Packaging

  • Packaging is similar to add-on selling in that it produces higher margin per ticket through the pricing out of entire selections of complementary goods – usually a room. A common way to do this is to print the price on the front of the tag, and list what is included. Some retailers also print the per month price for financing on the front, to show affordability. On the back of the tag the individual prices are listed. This has the following advantages:
  • It allows the customer and salesperson to envision a full-solution.
  • The total price is up front. There is no need for time-wasting addition.
  • The buying process is top down rather than bottom up. This means that the customer can start with a higher price and then take off items that are not desired. This will end up with a higher gross margin per ticket than starting low and going up.
  • Price negotiation can be minimized due to item substitution. If a customer wants to play the “What can you do for me on price?” game, a good salesperson can say, “This is our price for the whole package. What do you like most, and what do you like least? We can find a substitute for what you like least and perhaps get the price down. Sound good?”

#8 Discount Selling

There are two types of retailers out there. Some stick to their guns and sell on value. They have trained their salespeople and their customers not to play this game. The other type of retailer is the discounter. This retailer allows salespeople and managers to drop the price on any items up to a reasonable amount. A common strategy used is offering to pay for the customer’s sales tax. Discount sellers use making a deal as a closing tool and often encourage their customer’s to engage in this practice.

I’m not going to argue which way is better here. But due to the large number of retailers in home furnishings that engage in this practice, I am going to give a guideline so that margins can still be maximized. If you are an operation that negotiates, allow salespeople to discount only up to a certain percent on special orders, new items, and best-sellers. Incorporate this discount into your standard pricing multiplier so that at the end of the day you arrive at the same margin that you would have if you never played the negotiation game. On all markdowns, give salespeople extra room to make a deal as the prime objective here is to liquidate the dog product and free up a retail slot.

Now, I will also answer a common question I get in the field: “What if the customer finds a better price online?”

I am a believer that you should officially state that you will match all in market competitor’s prices for the same service offered. If it is directly comparable, match it and make the sale. To reduce the occurrence of this, re-brand any heavily shopped or show-roomed items to disguise the vendor and model numbers.

#9 Finance Pricing

Like discount selling, this ingredient of increasing margin may or may not be applicable to your operation. For those that promote long-term financing heavily in their advertising and encourage customers to take advantage of it, an additional price on the price tag helps. Simply use a higher standard multiplier that includes a component for the cost of financing. If a customer wishes the lowest price, your normal sale price, they must pay with cash, check, credit card or 12 month financing. An alternative to showing a higher price is packaging, mentioned previously. You can show the maximum monthly payment of a certain long term financing arrangement.

#10 Upping the Bar

The final ingredient in this recipe to maximize margin is upping the bar. Many businesses get stuck at a certain level of performance. However, if you go about tackling your margins using all ten ingredients outlined in this article, you will break through. Once you break through a previous barrier it will be even easier to grow further. Continue to review your performance. If you take your eyes off the ball, eventually you will experience margin-drift. Once you have mastered your margin recipe, look at upping the bar. Establish new minimum performance standards. Seek to find your gross margin ceiling – if it exists.

David McMahon is a Certified Management Accountant and Consultant with PROFITconsulting, a Division of PROFITsystems. Questions about this article, or to request a similar analysis on your financial statements contact him at Davidm@furninfo.com or call 8oo-888-5565.

Read other articles by David McMahon