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34 | www.cedmag.com | Construction Equipment Distribution | April 2014 Profit Improvement Report The last couple of years have seen distributors recover from the recession and enjoy some dramati- cally improved levels of sales growth. Some of that growth was the result of the acquisition of competitors weakened by the downturn. However, most of the growth has been organic. The economy may not be completely back on track, but sales have increased at a reasonable pace. Unfortunately, this sales growth has not translated into increased profits. While there was a very modest increase in dollar profits, profit growth lagged well behind sales growth across almost all of distribu- tion during this period. Sales growth proved extremely hollow. This report examines the sales growth versus profit growth dilemma from two different perspectives. n Profit Growth Pressure Points – An exploration of the two key factors that were behind the lag in profitability. n Changing the Sales-to-Profit Relationship – An identification of specific actions that firms must take to turn sales growth into profit growth. Profit Growth Pressure Points The profitability culprits for distribu- tors were pressures on the gross margin percentage and accelerating payroll costs. To be clear, distributors did not suffer any major problems in these areas. However, even extremely small changes have a large cumulative effect on profit. Exhibit 1 demonstrates the impact of sales growth on profit for the typical AED distributor based upon the latest CODB Report. As can be seen, the firm generates $50 million in sales, operates on a gross margin of 21.5 percent of sales, and produces a bottom line profit of 3.5 percent of sales – or $1,750,000. Three different scenarios are presented in the table. They all enjoy sales growth of 10 percent. The differences in the scenarios are related to what happens to gross margin and payroll expense as a result of the sales growth. The Business as Usual scenario assumes that sales, gross margin and total expenses all increase at the same 10 percent rate. The result is that dollar profit also increases by 10 percent. From a percent-of-revenue perspective, shown at the bottom, everything stays the same. Dollars up, but percentages flat. The second scenario, Profit Deterioration, reflects the profit challenges currently facing distribu- tors. In this scenario, gross margin dollars increase by only 9 percent while sales increase by 10 percent. Second, payroll expenses increase by 11 percent during the same period. With these minor variations, profit inches forward to only $1,762,500, offsetting most of the sales increase. The profit margin also declines, from the 3.5 percent starting point to just 3.2 percent of revenue. In simplest terms, even small, seemingly insignificant changes are not all that insignificant. The final scenario, Profit Enhance- ment, reverses the profit challenges. It demonstrates the effect of an 11 percent increase in gross margin and only a 9 percent increase in payroll. The profit impact, however, is not simply a mirror image of the Profit Deterioration results. The impact is dramatic, with profit rising to $2,087,500, an increase of 19.3 percent. Hello sales, good-bye margins – more dollars don't mean more profit, unless you keep tight reins on pricing and payroll. By Dr. AlberT D. bATes Watching Sales Growth Go to Waste 34_Bates_Profit_Feature_KP.indd 34 3/27/14 4:32 PM