You and I know that retailing is very complex. We get mired in this complexity when we begin to believe all we have to do is follow a few simple steps. We want better margins, lower costs and increased sales. But successful retailing is far more complex than that. Amidst this complexity, flooring retailers typically share four common goals: to increase (1) sales, (2) profit-margin this year, (3) “economic profit” (earnings) this year, and (4) “economic profit” in the long-run. Nearly all of us manage these common objectives well enough to stay in business, but few of us ever achieve our potential. I believe I’ve found a process you can apply to achieve your potential.
we fall short of our potential because of this infernal complexity native to
retailing. But recent research reveals that we work in deeper muck than we
thought. Executives at the international management consulting firm Marakon
Associates paired our four common objectives into two sets. Doing so, they
found that our primary objectives are actually at odds. Sales growth competes
against profitability, and the focus on short-term earnings competes against
long-term earnings. (The study’s authors, Dominic Dodd, a director, and Ken
Favaro, Marakon’s co-chairman, reported their study in “Managing the Right
Tension”, Harvard Business Review, Dec. 2006.)
As I read
their article and saw these four objectives paired up, I recognized the
problem. When we push sales, we usually have to sacrifice some profitability.
(Who hasn’t cut a deal to make a sale?) Each objective naturally tugs against
its partner; like a tug-of-war where progress on one side comes only at the
Dodd and Favaro offer hope. After studying some 1,000 companies over 20 years,
they discovered principles that allow retailers to reach the two objectives in
each set at the same time. They tell us we no longer have to think of our
challenge as a tug-of-war that can only be won by one side. Instead, think of
it as a tension-spring with an objective at each end pulling oppositely. When
we correctly coordinate the two objectives, we can successfully pull both
toward their goals. This coordination is the retailer habit I want you to adopt.
recall that I have urged you to push profitability over sales. This is because
when you increase sales but earn only modest profit, you see little reward for
a lot of work. That said, I also want you to grow your sales. My
recommendation: Net profits should be as close to double digit as possible, no
less than 10 percent. The same holds for the growth of your sales volume. The
market value of your company (when you’re ready to sell) is a multiple of the
cash it generates each year. Net Profit Margin sets the multiple; and cash is
the number it multiplies. So, the higher your sales, the higher your company’s
market value. (A 10 percent profit on $1 million is twice the cash of 10
percent of $500,000.) So, the better the Sales (along with profitability), the
more you may be paid when you retire.
study, Dodd and Favaro found few companies were able to grow both Sales and Net
Profit Margin in the same year. (Note: it’s Net Profit Margin, which is Net
Profit dollars as a percent of Sales.) Is your company among the “few” who grew
both? In how many of the last five years have you grown both?
the majority of companies choose between sales growth and profitability.
Flooring dealers face this question nearly every week: “Should I sacrifice some
profit to make a big sale?” When a major home-builder or big-order retail
customer demands a lower price from you, do you usually reduce the price to get
the sale? Or hold your price…and risk losing the sale? Most dealers drop their
price because they figure the sale will still cover the COGS and a good part of
the year’s fixed costs. (I’m not telling you that cutting profit is either bad
or good, it depends. My point is to remind you that however much you drop the
price, you should recognize that you are sacrificing profit for a sale.)
example of sales versus profit arises when working with credit-risk customers.
Do you close the deal even though you know you might be stuck with late
payments or a bad debt that would cut profits? Or when showroom-traffic rises,
do you encourage your salespeople to sell, even if the volume risks not serving
some customers thoroughly? At such times, do you dive into the transaction and
service customers, at the expense of running the business and watching costs?
After such a sales push, were you shocked to see how far your profits had
fallen even while sales soared? “We worked overtime for weeks. But we have
nothing to show for it!” Did you feel your sacrifice wasn’t worth it? Did you
switch back to focusing on profits? You are not alone.
both sales and profits is hard enough. Even fewer companies earned both a
short-term economic profit in the first year and long-term economic profit
every year for the next five. The temptation to sacrifice long-term earnings
for short-term gains is stronger, because it’s harder to foresee the long-term
damage. This is a dilemma for public companies, where they focus on short-term
profits and the expense of the long-term. Consider some examples. Have you ever
been so excited by booming sales that you let them exceed your capacity to
treat your customers properly? In the long-term, did your poor service sully
your store’s reputation for top-quality service? Did it take years to recover?
Have you scheduled your salespeople so thinly that when the traffic is heavy in
your store, they bounce from customer to customer, serving none well? In the
long-term, did they fail to increase their closing rates? Or have you borrowed
working capital, hoping to raise this year’s sales? In the long-term, did you
find your higher Interest costs sucked out all your new profits? Or have you
hired poorly to fill an immediate need, and suffered aggravation in the
long-term? Typically, when you push employees for growth today, they lose focus
on long-term strategy. Likewise, when you teach them to build for tomorrow,
they are distracted from producing results today. These opposing forces
confuse, distort and add to the complexity.
common error-and a big one too-is to focus on cutting costs in difficult times
and boosting sales in boom times. The error is failing to distinguish good
costs from bad costs, and good sales from bad sales. “Good costs” promote
customer benefits; bad costs don’t, they waste resources. A broad-brush program
to reduce costs too often targets the good costs along with the bad. Similarly,
“good sales” yield profits, while bad sales yield losses.
these cases, you can justify the first choice: you aim to raise this year’s
earnings, while hoping, of course, that later you’ll find a way to improve
long-term earnings. (Unfortunately, the “later” plans often don’t materialize.)
sets of competing objectives, it seldom works to prioritize one objective over
the other. In the profitability versus growth set, when dealers focus on
boosting sales, they typically lose control of costs, and margins erode. When
they seek to reverse the slide by boosting their profit margin, sales don’t
grow. So, they return to boosting sales. Similarly, in the short-term versus
long-term set, when managers focus on building for the future, today’s
performance slackens. When they seek to reverse that by focusing on today’s
earnings, they cut investment in the future, so future performance falters. So,
they return to building for the future. As a result, companies move first in
one direction, then in another, and then back again, never quite resolving the
problem. They are running in circles. Have you done that?
How do you get out of these
imprisoning circles that seduce you, but eventually weaken both objectives?
Dodd and Favaro recommend three steps. In the next few columns, I will describe
the three steps. Next, you’ll learn whether you are building economic value in
your company or, in effect, liquidating it.
Art of Retail Management: Habit -- Realize the fix you're in
March 16, 2007