Why Gross-Margin Percent Is A Poor Indicator Of Distributors' Profitability

Bruce Merrifield explains why high gross margin accounts and SKUs usually cost distributors more than they make, hurting profits.

Most distributors have naturally-occurring, High Gross Margin percentage (house) accounts and High Gross Margin percentage (small-dollar-pick) SKUs. These sales are surprisingly “Operating-Profit-Dollar” (Profit$s) losers.

The Gross Margin Dollars (GM$s) in these small-dollar picks and orders amount to less than the Cost-to-Serve Dollars (CTS$s) they consume, which means they cost your company more to fill than the Profit$s they generate for your company.

By contrast, direct-ship orders with low Gross Margin percentage are often quite profitable.

What matters at the line and order level, therefore, is not the Gross Margin percentage, but rather this profit equation:

GM$s - CTS$s Profit$

Note that Gross Margin Percentage (GM%) is not in this equation!

In fact, a higher Gross Margin Percentage will increase the Gross Margin Dollars, but the even bigger Cost-to-Serve Dollars total for excessive lines, orders, customers and SKUs remains unmeasured, unknown and larger than believed.

This “informational blindness” allows High Gross Margin percentage-losing sales activity to accumulate; and some profitable, Low Gross Margin percentage direct orders to be overbid and lost.

Getting Rid of High-Gross Margin Percentage Blind-Spots

A simulation game with financial statements tells us that both – Selling High and Buying Low – will improve Gross Margin percentage, Gross Margin dollars and the flow-through of the incremental Gross Margin Dollars to Profits.

So: higher Gross Margin percentage is GOOD everywhere and always (which doesn’t work on small dollar picks and orders!)

Of course, don’t underprice an outstanding Service-Value if you have one. If you can increase the prices on some items and to some customers and make them stick and not lose any business – then do it!

Otherwise, these blind-spots will hurt you as in the following examples:

  1. Buy-low, Sell-high is a zero-sum, win-lose goal. Your gains are your suppliers and customers’ losses.  But, what are your unmeasured costs for: lost-trust and increased price-shopping and haggling costs? After years of haggling has profitability improved?
  2. Financial analysis assumes that all of the underlying transactions, variables and dynamics summed up from last year are static going forward. They aren’t.
  3. Do you think you can service a few more, incremental, small picks and orders without increasing expenses? Distributors that do Line-Item, Profit Analysis discover, on average, that 70 percent of all lines have losing profit-equations. And, 65 percent of all orders and 80 percent of all customers are losers. Therefore, losing “busi-ness” eats all change ideas.

Learn and apply CTS Math to significantly improve these statistics and cure profit-losing equations. Watch both sales and profits soar by taking the following three simple steps:

  1. Watch the 3-minute excerpt below from our recently released “Cost-To-Serve Math” course.
  2. Check out waypointanalytics.net and request a demo.
  3. Attend the Advanced Profit Innovation Conference Feb. 29/March 1st in Phoenix. (apicconference.com)
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