All that Glitters is Not Gold

Outside of senior leadership, many employees do not spend much time talking or thinking about our “cost-to-serve” or “transaction costs” when it comes to generating sales. Depending on where you sit in the organization, your view of profitability (and success) may vary widely from other employees—and from reality.

Business leaders need to make sure that company sales representatives understand the true transaction costs or “cost-to-serve” when it comes to processing an order, so the company is adequately compensated for providing an exceptional customer experience.

So, let us look at those costs with a simple example of one salesperson who sold $6.5 million with a gross profit margin of $ 1.17 million at 18%. To achieve these numbers, the company processed 8,000 invoices (32 per day) in support of its customers.

Below is a traditional view of this salesperson’s results for the year.

It is normal for us to look at our sales team’s performance and ask:

• How much did we sell?
• How much did it cost us?
• How much did we walk away with?

What neither the sales manager nor the salesperson were aware of was that the costs for the company to process each invoice was $200. The only people in the company that knew this were the CEO and CFO. The information had not been shared. When you consider your transaction costs and allocate them on a per-invoice basis, it provides a truer measurement of profitability.

When we take those 8,000 invoices and we multiply them by $200, we find that it cost the branch $1.6 million to process those invoices. So, here is a truer picture of the numbers from above. Instead of making $1.17 million at 18% like they thought, the reality was they lost $430,000 and their percentage was a negative margin of 6.62% in what we refer to as extended gross margin and extended gross margin percent.

Can you see why it is so important for your organization to understand the importance of knowing your transaction costs or cost-to-serve? Do you see how this concept links to the conversation around pricing discipline, upselling and promoting services? In the above example, the sales professional and their sales manager were thrilled by the $1.17 million in margin. They neither knew what their transactions costs were nor were they ever approached on the subject. The leadership team looked at the same data and saw a loss of $430,000 and 24.62%. The reality was they actually paid their customers $430,000 for the privilege of buying from them.

And we are only looking at one salesperson here. Imagine the importance of this topic if your company has 10 or 15 or 20 plus salespeople.

There are workable solutions for our salesperson and their “portfolio” of customers. One of them has to do with understanding why our salesperson is generating the number of invoices that they are receiving. In many cases, 80% of their volume represent the majority of those 8,000 invoices (or 32 invoices per day) which led to the $430,000 lost margin.

One of the things we have discovered is that every salesperson’s base has a story. Meeting with our salesperson and their manager and looking at their accounts will reveal which customers are creating the most invoices. It allows us to find answers to questions like:

• Are we delivering and processing 4-5 or more invoices a day?
• Are we consolidating orders when we can internally?
• Are we automatically shipping when available or can we ship when complete?
• Have we reached out to our customers and tried to understand what we can do to consolidate or reduce the number of deliveries or invoices with them?

The last bullet point is important because our customers also have transactions costs, so having a meaningful conversation with them, backed with real data, could create a win-win for both of us and allow savings on both ends. Very few distributors have these types of business conversations with their customers. This is an excellent opportunity because their costs most likely mirror our own.

These discussions can help create an environment of transparency, candor, honesty and trust that may strengthen the relationship between us and our key customers and allow us to pick up more of their discretionary business.

Small improvements can have huge positive impacts!

We asked ourselves what would happen if we had meaningful conversations with our salesperson’s key clients and were able to reduce the number of invoices by 10%? If we could reduce the number of invoices from 8,000 (32 per day) at a transaction cost of $200 down to 7,200 invoices (29 per day). How much of an impact would three less invoices a day have on the business?

In the graphic above, we wanted to see what the incremental savings to the branch would be if we were to go from 8,000 invoices down to 7,200. Or, more simply stated from 32 invoices a day down to 29.

If every invoice cost the branch $200 and we could go from 32 invoices a day or $6,400 down to 29 invoices a day at $5,800 we would be saving $600 a day. And if we multiply $600 times 250 workdays, we have potential savings of $150,000! And that’s just from one salesperson!

If you had 10 salespeople (using the numbers here) and each of them were able to reduce the numbers of invoices by 10%, there could be the potential for $1.5 million in incremental savings with our sales team that drops right to the bottom line. Not suggesting everyone reduce their invoices by 10%. But where it makes sense to do so, you can see the positive impact on earnings.

Experience has taught us that when the workforce becomes aware of the costs and challenges associated with running the business, they better understand why driving margin is vital. Motivated and knowledgeable employees working on driving financial results are a beautiful thing to see, especially when higher net income is the result.

So, in the end, we know it is a constant battle between improving our operational efficiencies, driving financial results and sharing our successes from a people, profits and customer perspective. But when you can get the entire distributorship to see the business through the same lens… this is a very good thing.