Issue link: https://www.e-digitaleditions.com/i/480616
36 FEDA News & Views Editor's Note: Despite appearing in a 2008 issue of News & Views, it is quite telling that Dr. Bates' analysis in the following article is eerily similar to data in the next FEDA Profit Report. More importantly, it speaks volumes on the dealer's need to embrace a system for measuring customer profitability. O ver the last 10 years, FEDA mem- bers have relied upon increasing levels of employee productivity to drive higher profits. For example, in 1991 the typical FEDA distributor gener- ated slightly over $200,000 in revenue per employee. As of 2007, the figure had reached $370,000. This represents a compound annual growth rate of 3.7 percent per year. At the same time, profitability has shown almost no increase at all. This does not suggest that employee pro- ductivity is not important. Instead, it suggests that distributors continue to do too much work. They tend to have an average order size that is too low and they generally deal with too many unprofitable customers. The workload challenge is outlined in Editor's Note: is eerily similar to data in Money Matters Doing Less Work and Producing More Profit Dr. Albert Bates, Profit Planning Group Exhibit 1. For the typical FEDA distribu- tor, the average order value is around $600. This means that on each order, the distributor produces an operating profit of $18, or 3 percent of sales. Clearly, just a small problem on the order—heavy traffic on the interstate, an error in order assembly, or anything else—could more than wipe out any profit that was gener- ated. At the individual order line level, the situation becomes even more acute. With a profit of only $3 per line, the need for efficiency becomes obvious. Quite literally, every minute of employee time is critical. Errors and inefficiency must be eradicated. The final column in Exhibit 1 looks at the profit earned per individual cus- tomer, which gets to the heart of this report. On a typical $15,000 account, the distributor will process 25 orders and pick 150 lines. All of this in the expecta- tion of an operating profit of $450 over the course of the entire year. At a truly micro level, that is about $1.23 of profit per customer per day. In short, FEDA distributors need to rethink their internal operations as much as they need to keep generating higher levels of employee productivity. In trying to make the improvements, one point emerges immediately—all customers are not created equally. In point of fact, the customers that appear to order in small quantities and order too frequently also appear to be the same ones that have too many emergency orders and too many returned items.They also tend to be the same ones that pay slowly. There is a need to look at customers individually. How Customers Impact Profit The relationship between customers and profit for a typical FEDA distributor is reproduced in Exhibit 2. In reviewing the exhibit, it should be remembered that every firm has a slightly different situation. What is shown in the exhibit is what tends to happen more often than not. What the exhibit indicates is that customers can be organized into four very different categories—A, B, C and D. This is similar to the velocity codes that most distributors use to categorize their product lines. The difference is that item velocity codes are based entirely upon sales volume. The customer categories, in sharp contrast, are based solely upon profitability. The A Category of customers is not the largest group of customers. Instead, it is the most profitable group. As can be seen, the most commonly encountered relationship in distribution is that this small group of customers produces 100 percent of the firm's operating profits. For the typical firm identified earlier, this is $450,000. At the other end of the profitability spectrum, about one-third of total cus- tomers fall into the money-losing cat- egory. In aggregate, the losses on these customers are equal to 45 percent of the firm's total operating profit. The typical distributor, according to the FEDA PROFIT Report, generates its $15 million in sales by servicing some- Exhibit 1 Income Statement for a Typical Firm Total Firm, Per Order, Per Line and Per Customer Total Firm Per Order Per Line Customer Net Sales $15,000,000 $600 $100.00 $15,000 Cost of Goods Sold 11,025,000 441 73.50 11,025 Gross Profit 3,975,000 159 26.50 3,975 Operating Expenses 3,525,000 141 23.50 3,525 Operating Profit $450,000 $18 $3.00 $450