2019 Profit Report

Free - Firms Who Participated in Profit Survey
$250 - NFDA Members
$500 - Non-Members

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Checking Financial Performance By Asking Three Questions

Many firms are feeling competitive pressure on gross margins and upward pressures on costs, particularly payroll. In this mixed environment, this report helps answer three key questions all NFDA members should be asking:

• How are we doing?
• What is the typical level of profitability in the industry?
• How good can we be?
• How are the most successful firms performing?
• How do we get to high-profit results?
• Which of the Critical Profit Variables (CPVs) appear to drive profitability?

Typical Versus High-Profit

The first two questions are easily answered by examining the figures in the top part of Exhibit 1 below. These figures present two different measures of profit for both the typical NFDA member and the most profitable members.

Profit Before Taxes % measures pre-tax profit as a percent of revenue. For the typical NFDA member this figure was 5.7%, while the high-profit firms enjoyed a 7.8% PBT.

Return on Assets (ROA) calculates the same pre-tax profit figure as a percent of the total asset investment in the business. Again, there is a striking difference with the typical firm at 11.4% versus 19.5% for the high-profit firms.

The Critical Profit Drivers

The key to moving from typical to high-profit levels of performance is understanding the nature of the CPVs. Namely, which ones are most important and how did they impact performance for the typical and high-profit firms.

Managing the CPVs

The CPV results for the typical firm and high-profit firm in the industry are summarized in the bottom half of the following table. While some other factors can be examined to evaluate performance, these are the ones that really drive performance.

One common misunderstanding regarding the CPVs is that to be in the high-profit group it is necessary to 1) do a lot better than the typical firm and 2) do a lot better in every CPV. But nothing could be further from the truth.

In reality, some of the differences in the CPVs between typical and high-profit are often extremely small. But the small differences tend to multiply to produce major changes in profit margin. In other words, “little things mean a lot”.

It is also often surprising to learn that it is not even necessary to do a little better everywhere. No firm produces superior results for every single CPV in either good times or bad. Successful firms manage their CPV performance to maximize overall profitability. This also is great news for the typical firm. Perfection is not required, only blending the CPVs in a positive way. With such blending, profit rises significantly.

The CPVs that are the most important contributors to enhancing profit are sales growth, gross margin, payroll expenses and non-payroll expenses. Each factor must be planned carefully to ensure adequate profits.

Sales Growth

There is a common misperception that sales will solve all problems. Sales certainly do help with most problems. However, the ideal level of sales growth is in a fairly narrow range. Excessively slow growth certainly creates profit problems. Interestingly, excessively rapid growth does also.

Slow sales growth means that expenses, which tend to be tied closely to inflation, out-pace the rate of growth so that expenses as a percent of sales increase. While very few firms believe so, rapid sales growth is also a problem. Financing rapid growth is always a challenge, and operating systems can get taxed when sales growth is too rapid.

The rate of sales growth that allows firms to operate without serious financial challenges depends upon the rate of inflation. The “ideal” rate of growth is the inflation rate plus three to six percentage points. So, if the inflation rate is 2.0%, then ideal sales growth would be in the 5.0% to 8.0% range. This should be viewed as a minimum. Firms may grow faster, but without basic growth, profit improvement is very difficult.

Gross Margin

Price pressures never go away, even if sales are growing. It would seem that as sales growth takes hold, firms would enjoy a pricing advantage. The reality is just the opposite. The excitement associated with increasing sales tends to cause firms to become lax with regard to pricing control.

In almost every industry an adequate gross margin is a major determinant of profitability. The real driver behind improved, or at least maintained, gross margin performance is continual monitoring. There is not a firm in any industry that could not make a modest improvement in gross margin, even including the high-profit ones.

Gross margin, in turn, is largely a pricing issue. Margin enhancement through pricing changes must involve stretching the price matrix. In simplest terms, distributors tend to be price aggressive on fast-selling items, which they should be. However, they tend to under-price slower selling items. It is a substantial opportunity to raise gross margin. Of even greater consequence, it is payroll-expense free.

Payroll Expenses

Payroll is always the largest expense in a distribution business so controlling it is essential. Payroll is another area where a specific improvement goal can be established. Ideally, payroll costs should increase by about 2.0% less than sales. For example, if sales increases 5.0%, payroll should be limited to a 3% increase.

At first glance, controlling payroll growth would appear to be a relatively simple, and probably easy, to achieve target. The reality is a different story. Controlling payroll becomes even more difficult in a growth market. Firms often hire in expectation of even more sales growth. Additionally, the same "eye off of the ball" problem associated with gross margin also takes place with regard to payroll.

Non-Payroll Expenses

The non-payroll expenses are the "least difficult" of expenses to control. Most of these expenses can be brought into line as long as sales really are rising faster than inflation. The vast majority of these expenses are directly related to the rate of inflation. As long as sales growth is maintained above the inflation rate, there is the potential to lower the non-payroll expense percentage.

Moving Toward High-Profit Results

The high-profit firms produce great results virtually every year. They also reflect the fact that there are no industry barriers to success. The key to improving performance is developing a specific plan for each CPV and combining them in a positive way. Perfection is not the goal. The goal is to do a little better across the board. It's a goal that's open to every firm.