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38 FEDA News & Views 2014 Distributor Profitability Trends Report Getting the Profitability Yo-Yo under control continues to be a challenge, according to findings by the Profit Planning Group As a group, distributors experienced slowing sales growth during 2013 (the last year for which complete information is avail- able). This led to an increase in expenses as a percent of sales but that problem was more than offset by an increase in the gross margin percentage. The net result was a slight increase in profitability. Unfortunately, the results do nothing more than illustrate an up-and-down pattern—a profitability increase in one year followed by a decrease the next—which suggests that real profit improvements are still somewhat illusory. The following paragraphs review the key findings from the 2014 Distributor Profitability analysis. It is important to note that comparisons across industries are challenging. Some factors can be compared directly, while others cannot. Sales growth, for example, can be compared industry by industry. If one industry grows and another does not, it is a directly measurable factor. Given the significance of sales growth in driving profit, such comparisons provide direct insights into profitability. On most of the factors that influence profitability, though, direct comparisons are not possible. Some distribution industries, for example, have high gross margin percentages while others have low percentages. By the same token, some industries have high-expense ratios while others have low ratios. Similar differences exist with regard to inventory turnover and account receiv- able collection patterns. For all of these factors, such as gross margin, the key is the degree of change. If the gross margin percent- age is declining for a specific industry while the rest of distribution is increasing, it is a clear indicator that attention is needed. The Distributor Profitability Trends Report includes six exhibits that cover overall financial results and the Critical Profit Drivers (CPVs) that underlie the profit trends. Each exhibit is reviewed briefly in the following paragraphs. Exhibit 1—Return on Assets (ROA) is the best overall measure of distributor profitability. It is profit, after all expenses but before income taxes, expressed as a percent of the total asset investment in the business. Simply put, it reflects the economic viability of the firm. ROA fell from 2009 to 2010, increased in 2011, fell again in 2012 and then finally rose again in 2013. It was, to use the title of this report, on a yo-yo path. Individual industries deviated from this up-and-down pattern due to conditions unique to a single line of trade. However, distributors, in aggregate, could not develop any real profit momentum during the five-year period and were able to maintain adequate, but unexciting, profit levels. ROA hovered in the 6 percent to 7 percent range. This is enough profit to be able to continue to expand modestly, but is below the 10 percent level that would note very strong profits. 0.0 2.0 4.0 6.0 8.0 10.0 2009 2010 2011 2012 2013 ROA--% Year Exhibit 1 Return on Assets by Year All Industries FEDA 0.0 2.0 4.0 6.0 Industrial Construction Consumer FEDA Sales Growth--% Industry Segment Exhibit 2 Sales Growth by Industry Segment 2013 Versus 2012 Exhibit 2—The most important factor taking place in 2013 was the moderat- ing of sales growth. In 2012, sales growth was in excess of 5 percent for the industries tracked in the profitability trends report. In 2013, as shown in the exhibit, sales growth fell back into the 4 percent range. This was true across all three sectors analyzed—distributors selling largely in the industrial market, distributors selling into the construction market and distributors selling directly to consumers or to retailers ultimately selling to consumers. A mere 1 percentage point decline in sales growth may seem trivial. However, long-term historical evidence suggests that sales growth in excess of 5 percent is needed to help firms offset cost increases and improve profitability on an on-going basis. The fact that profitability ticked up slightly in the absence of strong sales growth suggests that some other factors were at work. Those factors were the combined impact of the other CPVs—gross margin, operating expenses, inventory turnover and the DSO. By Dr. Albert D. Bates, President, Profit Planning Group bigal@profitplanninggroup.com