Gross Margin Is In Your Head
Volume 142 NO.5 September/October
Furniture World Magazine
By David McMahon
The most common objection I get from business managers when I suggest that their margins should be improved is, "We can't increase our prices. We have too much competition and we will lose sales!"
Sorry, that excuse does not fly. It has been proven to be wrong over and over again. In the performance groups that I lead, many retail furniture businesses approach 50 percent gross margin and some are over 60 percent! And all these businesses are in competitive markets. In this article I am going to reveal some of the practices that successful retailers use to maximize margins.
The first thing to understand is that margins are in your head. You achieve the margins that you do because that is what you think you can get. It's like the saying, "if you think you can or if you think you can't, you are right”. If you believe that you should price all merchandise at a number (50 margin or 100 mark), then that is the most you will get. Ever! In fact, you will probably get between 42 and 45 percent at the most due to discounting. To break the 50 percent barrier the old number pricing practice needs to be thrown in the garbage. Open your mind to pricing and you will make a ton more money.
You see, outside of products that are fixed cost commodities with no substitutions, margins are flexible. To the consumer, the product is worth what they pay for it. To the salesperson, it is worth what they sell it for. If a customer buys an item for $499 from a salesperson, neither of them really care whether you bought that item for $200 or $250. If product value and customer service are in place, and there is no easy comparison point, the price can be flexible.
I can hear you questioning me now, "But, there is a comparison point. Our competitor carries the same thing, people shop around, and what about the internet?"
Right, customers do shop around and if you make it more attractive to do business with you, they will shop with you more than your competition. And, you really don't have to make it that easy to shop you... do you?
Margins Are Both Art And A Science
They are an art form in that you can be flexible in your pricing techniques. You can use different approaches for different items. One size does not fit all in art. Be creative.
Margins are a science too because at the end of the day the mathematical equation of (price sold - landed cost purchased) / price sold is what you get. Your results should be studied from a non-emotional level. Be analytical.
Here are some art and some science practices that have been used successfully to increase gross margins.
Don’t Let your software system be your only guide.
For pricing on newly received merchandise, don't let your computer be the final determiner of your selling price. The human element in pricing is critical. For example, if you want to achieve approximately a 50 percent margin for a particular vendor, set a cost multiplier of 2.25 over landed. That would deliver a 55.5 margin for that price. So, if an item cost $200, the system would spit out a price of $450. Then the buyer should physically look at the item and ask, "Does this price make sense? Or, should it be priced more or maybe less?" In this case, if the buyer believes the item could fetch $499 it should be changed in the system. Then the price tag should be printed. If you let a computer be the sole determiner of the final price, you will end up with odd ball pricing and leave a lot of dollars on the table. It is well worth the extra work. A few extra dollars here and there will add up to thousands of dollars in additional profits.
One of the first things I do when visiting an operation is to walk the showroom and look at the price points. When I do this, I don't even need to see costs to come up with extra margin. Often, I will notice bizarre price points. For example, furniture will be offered at $209 and $1,256, instead of $199 and $1,299. This obviously occurs because a strict formula is being followed. Businesses that produce the highest margins are flexible in their pricing.
Price best sellers right.
Being analytical is important. It is most often the case that the minority of the products that you offer contribute to the majority of gross margin dollars (aka 80/20 principle). Knowing and pricing these best sellers properly is critical. Routinely, pull best seller item detail reports from your ERP (enterprise resource planning) system. Look at the retail price and the gross margin percentage produced. Check to see if the prices are proper for best sellers. These items are proven to sell and a few percentage points in gross margin rarely make a difference to customers. It does however make a big difference to the business over time.
Stock best sellers more often.
If you agree with me that winning items produce the lion’s share of gross margin dollars, you will also agree with me that if you keep them available in front of customers and salespeople, you will sell more of these items. In this, it is a numbers game. Higher best seller in stock days equals greater gross margin.
Value price on custom jobs and special orders.
Buying something as is, off the shelf is easy for processing. If the customer wants it the way they see it, they pay for it and they take it home or get it delivered. There are few additional expenses for the company as the costs are sunk (incurred already). Anytime there is a customized change in how the customer wants the product, extra costs are incurred by the business. There are increased time costs with the salesperson organizing the order, purchasing costs, freight costs, warehousing costs, distribution expenses, and sometimes additional service costs. Often times I see that businesses charge the same price as if they were selling an in-stock item. I suggest charging a higher mark up for customization and / or a distribution fee. This is an additional service you are rendering. If you want a really simple way to do this, just tell your salespeople the new policy is to charge 2.5 x vendor catalogue cost. It is okay to charge more if you are giving additional value.
Do you have a good name brand in your market area? If so, you should have a private label program. There is no direct comparison for consumers, and there are countless vendors around the world and maybe even locally that can help you achieve a lower cost and higher margin. Whether you are selling furniture, mattresses, accessories, clothing, or pet food, you should have a private label line. Whether you cater to high society or the blue collar customer, you should have a private label line. And if you don't feel like your name brand is the way to go, make up a brand. When sourcing suppliers I suggest that you look for these key elements: past private label success, extended terms, quick shipping lead times, product support, brand comparable quality or better. Your private label brand does not need to be the cheapest product. It can be at any price point level that you offer. Some very successful businesses have exclusive high end lines and achieve large margins in this space.
Private label branded merchandise.
Most of you reading this carry national brands. All of you hate getting shopped. Whether it is an internet business or your competitor across the street, consumers find it easier than ever these days to shop you. They can just pull up their smart phone and use one of the many apps to search your product. There is a fairly simple way around this. Just stop putting your real model numbers or style names on the products that you are being shopped on. For example, if an item is called the Hemingway Chair, you might rename it the War Hero's chair on the price tag only. Your ERP system will most likely have an extra field you can use to accomplish this.
A word of caution. Don’t rename everything. You need the real branded models too on various products. And, consider pricing select products at a low margin so you can encourage price shopping that will result in your prices being much better than the competition. One client actually encourages price shopping on their web site. They say on their home page: "Come in and our salespeople will help you price shop on their iPads.” Now that’s confidence. By the way, their margins are above all their competitors.
Buy with a mission rather than gut.
Often buyers attend furniture markets without a clear strategy. Sometimes they show up with just a vague idea of how much money they would like to spend, and then roll the dice on what they feel is the next hot thing. They are primarily concerned about the cost of the item and later figure what they can sell it for. They price cost plus. If this is how you approach buying, try this at your next show. Put aside a certain amount of your open to buy. Before leaving for the show, run a best seller report in your ERP system and find out which price points have been producing for you. Figure out where the gaps are, then plan on which price points to add to the lineup. Then, when you go to the trade show, look for merchandise that you think you can sell at whatever price points you have open. Then look at thecost. What's your margin? If it is more than expected and the terms are good, give it a shot.
Mark down slow moving merchandise on a quick schedule.
We all know that discounting and blow out events hurt margins. Businesses that sell at a more consistent rate without having to go deep into their profitability pockets several times per year end up with much higher cash flow. The key is proper inventory management and focus on GMROI (gross margin return on inventory). With respect to margins, one field-proven way to increase gross margin is to mark down in incremental steps sooner, and to enable a faster sale of non-gross margin producing inventory. You should set up an aging on your inventory that pulls out the $0 gross margin producers. Then, you should initiate an associated mark-down percent that is related to the days aged. For example, if an item does not produce in 45 days of carrying, then an automatic markdown of 10 percent may be executed. If it does not sell in another 45 days, an additional 10 percent discount may be applied.
If that item was then sold at the 20 percent discount in 90 days, it is still a lot more productive than if the item was stocked for 365 days and finally sold at 50 percent off. You would have gained extra margin, faster turns, and a new opportunity to free up floor or shelf space to try a new item that might produce. Bottom line - it is better to turn and burn than to hold and lose.
Incentivize high gross margin sales.
If you believe people will do what you lead and pay them to do, this will work for you. If people are not led or paid right, it may not work. Here is the practice: instead of paying a straight commission percent on the sale, pay a variable percent.
The key is that the variable percent is determined by the gross margin percentage sold. This can have a huge impact on profitability. It can almost eliminate using negotiation and discounting as a salesperson’s tool. When implementing, it is important to set a spread between a high commission rate and a low commission rate of at least 5 points. The high is tied to high gross margin sales, say 60 percent and above. The low commission rate is tied to low gross margin sales, say 30 percent. Everything in between is on a variable rate. Note that this is only an example and any business setting this up must analyze its individual model first to determine the proper rates to maximize gross margin. Most businesses that have implemented this system say that they have increased margins between three and nine percent. Combine this type of incentive program with a team bonus and a pay for performance and your team will succeed in delivering higher margins.
There are more ways to increase margins.
Try to be both analytical and creative and you can find them for your unique situation. It is worth the work, as the improvement has a direct impact on your net income and cash flow at the end of the day.
What was that objection again? Oh, something about "can't" and not increasing prices for fear of lost sales and competition? Don't fear. You deserve to make a healthy margin for the value that you deliver. Margins are in your head.
David McMahon is a Certified Management Accountant and Consultant with PROFITconsulting, a Division of PROFITsystems. Questions about this article, or to request a similar analysis on your financial statements contact him at Davidm@furninfo.com or call 8oo-888-5565.
Read other articles by David McMahon