Distributors Profits Improve

August 28, 2006
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Businesses often teeter between ordinary and great. What separates these two positions is really very little. When it comes to dollars and percents, however, little things count incredibly.

With the release of the 2006 Heating, Airconditioning & Refrigeration Distributors International (HARDI) profit report, Dr. Albert Bates, CEO of Profit Planning Group, Boulder, Colo., also released his analysis of the organization's results in "Controlling the Key Profit Drivers: Implications from the 2006 HARDI Profit Report."

NUMBER CRUNCH

Distributor sales growth increased 11.5 percent in 2005 over 2004, according to a polling sample of 100 HARDI distributors across America. The pretax profit margins also continued a five-year climb, totaling 3 percent, a 58 percent increase from the record low in 2001. According to the HARDI report, average staff sizes increased by one member and sales per employee were up 8 percent from 2004-05, and 13 percent from 2001. HARDI partially attributes the sales per employee increase to the use and advances in technology. A 6 percent increase in gross margin per employee rounded out the HARDI profit report, bringing the five-year total to 19 percent. That is an average of 3.8 percent a year since 2001.

"There are very few wholesale channels in other industries that can say they've had five consecutive years of improving margins," said Don Frendberg, HARDI executive vice president and COO. "However, what I believe is more telling from the report is the emphasis HARDI distributors place on continually increasing efficiency and reducing their cost of doing business through greater utilization of technology."

Click on the chart for an enlarged view.

TYPICAL vs HIGH PROFIT

Increasing profit margins in the wholesale business is extremely difficult when, according to HARDI, sales have to grow 11.5 percent to generate a 0.2 percent increase in net profits. When analyzing a typical firm and a high-profit firm, Bates found that a typical firm often has 3 percent profit margins, whereas a high-profit firm often has 6.2 percent profit margins.

In determining the reasons for this phenomenon, Bates came to the conclusion that two primary factors are crucial for a wholesaler to become high profit - critical profit variables (CPVs) and the development of an improvement action plan to reach high-level profit goals.

Over the past 25 years, experts have identified many critical profit variables. Bates proposed that sales growth, gross margin, and payroll expenses are the three most common CPVs that drive profitability. Moderate sales growth is mandatory for long-term success. Rapid sales growth is not a requirement for driving higher profits, said Bates. Keeping up with ever increasing operating expenses is imperative, however, which is what requires mandatory moderate sales growth.

Gross margin is another CPV that wholesalers find elusive. "The ability to generate an adequate gross margin is one of the major challenges facing almost every firm," noted Bates. "Pressure comes from both the suppliers who desire more efficient product distribution and the customers who are increasingly price aggressive."

Payroll expense is the third pivotal CPV proposed by Bates. In most industries, payroll and benefits are the most important expense factors affecting profit margin growth. In order to calculate the ratio of payroll expenses to gross margin, add SG&A payroll plus benefits and divide by the gross margin.

"Strategically, this measures how much it costs to produce the value the firm provides to its customer base," said Bates.

MAKE A PLAN

Once these three CPVs have been identified and defined, it is time to make an improvement plan. Bates suggests that businesses don't try to make every improvement in one year - "go slowly and systematically."

For sales growth, a realistic goal is 1-2 percentage points growth faster than the wholesale industry as a whole, according to Bates. The growth sales margin improvement plan should contain an improvement target of 0.1-0.3 percentage points increase per year. The payroll to gross margin ratio is better, the lower it is.

"An annual decrease of 0.5-1 percentage points is realistic," said Bates. "The challenge comes in generating these improvements simultaneously."

Sidebar: New Solutions Center

HVACR distributors will have multiple solutions available to them to meet business challenges when they attend Heating, Airconditioning & Refrigeration Distributors International's (HARDI's) 2006 fall conference.

The conference will be held in Palm Desert, Calif., Nov. 4-7, 2006. HARDI is debuting a new HARDI Solutions Center to showcase the offerings of its Service Vendor and Purchasing/Marketing Group membership. The new Solutions Center will be limited in number and segmented by service category to help HARDI distributors find solution providers for their most urgent business needs.

HARDI distributors will have resources showcased for business services (marketing, insurance, financial services, consulting); education and training (technical, management, sales instruction); technology and software featuring a HARDITek Pavilion; and other resources (industry organizations and reference materials).

The HARDI Solutions Center will also be available to member Marketing/Purchasing Groups. HARDI currently has four Marketing/Purchasing Group members, all of whom are invited to participate in the HARDI Solution Center.

Registration for the limited spaces in the Solution Center will open in early August and will be filled on a first-come, first-served basis. Registrations to attend the HARDI 2006 Fall Conference will open later in August. For more information, visit www.hardinet.org/conference.

Publication date: 08/28/2006

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