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Margin Management - Using the Supplier Profitability Ratio to Hold Your Vendors Accountable

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Margin management is not rocket science. Improving gross margin is simple. You must either raise prices or reduce cost of goods sold. But, there is a little more to it than that when you consider net profit. Consider doing an activity based costing analysis on your entire account base. There are plenty of instruction manuals published on how to do this. I guarantee you that you will find some surprises. You should also consider implementing a “Margin Hold” system that forces management approval on orders entered below a minimum established threshold for gross margin percentage.

On the Sales Side

Ultimately to create margin improvement, your entire sales team must have good judgment of market potential as it relates to margin improvement. They must be self disciplined and make intelligent decisions based on fact. Each territory manager must develop his own plan for profit improvement and be flexible on the implementation of that plan. They must be action oriented and customer driven and yet be extremely conscious of profitability objectives.

Results must be measured against the plan. Trend lines need to be established both on revenue and profit growth. They must be able to see the rewards for their efforts. They must accept responsibility and accountability for improved profitability and achievement of established objectives. They need to understand activity based costing.

On the Buy Side

The buy side of the equation also offers numerous opportunities for margin improvements. Approach all of your vendors. Don’t be afraid to demand cost reductions. Your customers certainly aren’t embarrassed to ask you. Review your entire purchasing organization. Do you have true buyers or are they simply order schedulers.

Establish specific inventory reduction goals, turn-rate increase and fill rate improvement. Incenticize the critical success factors on the buy side, factors such as, margin improvement, inventory reduction and inventory turn rates. Include any others specific to your initiatives for profitability.

Try to take advantage of any "itchy-scratchy" opportunities. (A new term I learned from some friends in Detroit.) These are opportunities where you are buying a product from someone that uses the types of products you distribute. The academic term is "reciprocity". The following is a checklist to review when considering margin improvement objectives.

• Do you have an established pricing policy?

• Do your pricing policies consider market segmentation, risk, service levels and value added?

• Is your counter sales/will call priced according to margin objectives?

• Do you have well trained buyers and do they negotiate?

• Is your purchasing/inventory control department managing the inventory well? Are they using the correct volume discount and item analysis?

• How do you measure your fill rate? Do you bench mark it to your competition?

• Do you have a system to review and evaluate your RGA’s? (Return Goods Authorization)

• Do you charge for restocking?

• Are you getting the optimum discounts from your supplier and are you keeping the discounts as profit?

• Have you done a supplier profitability analysis?

• Are your customers profitable?

• Do you have significant supplier error?

• Do you have a vendor returns program and do you manage it well?

• Do you track your own and your suppliers on time delivery? • Are you selling the right products to the right customers?

• Do you have an outcall program?

• Does your inside sales force understand the concept of up selling?

• Is your warehouse operating efficiently?

• Do you have a freight recovery program or do you fold under pressure and give it all away?

• Do you rank and evaluate your customers by gross margin dollars and gross margin percentages?

• Do you have an incentive program that is tied to gross margin growth both in dollars and percentages?

On the buy side of the equation, you must be able to determine which of your suppliers enhance your margin opportunities and which suppliers detract from it. Add up all the things that each supplier does to help you increase profitability.

Supplier Margin Contribution Enhancement

What is your discount structure with your supplier and how does it rank in your competitive analysis? Are you getting the same discount or better than your competition? What are your total gross margin dollars earned by supplier? Rank your suppliers accordingly to be used as a weight factor. Apply a 1 to the lowest ranking, a ten to the highest and an appropriate number for those in between.

Group your suppliers into dollar categories to minimize the number of rankings. If you have one hundred suppliers, apply the 80/20 rule and rank the top ten, the middle grouping and the bottom 10. Apply any form of this scale that makes sense to your specific circumstance. The objective of this exercise is to simply determine if your suppliers are making a genuine effort to enhance your profitability.

Include cash discounts, rebates, co-op advertising, special terms and any other special incentives offered. Quantify in dollars all the enhancements each supplier offers.

Supplier Margin Detraction

Quantify each and every issue that contributes negatively from profit enhancement. Issues to be considered are excessive inventory carrying costs due to extended lead times, late shipments, missed deliveries, inability to direct ship, excessive conversion costs, rework, packaging issues, lack of or restrictive return policy and the general level of co-operation and willingness to keep you competitive in the market. Some of these issues are easily quantifiable. Others may require an arbitrary assigned dollar figure based strictly on gut feeling. What is the real cost of a lost order, a late shipment etc.? Guesstimates are okay as long as you are consistent in your application. Total all those negative costs to determine Supplier Margin Detraction.

Common Margin Detractors

• Short shipments/wrong counts

• Missed promise date

• Damaged goods

• Partial shipment

• Lost back order

• Incorrect technical advise

• Pricing errors

• Wrong or no part number

• No packing slip

• Illegible documents

• No PO number

• Duplicate shipments

• Wrong PO number

• Poor customer service/response

• Faulty products

• Difficult claim procedures

• Shipment to wrong location

• Non responsive to emergency requests

Supplier Profitability Ratio

We can now determine The Margin Enhancement Rating and The Margin Detraction Rating so we can create a Supplier Profitability Ratio using the following formula.

TGM= Total Gross Margin

ME= Margin Enhancement

MD= Margin Detraction

SR= Supplier Rating

SPR= Supplier Profitability Ratio

MC = Margin Contribution

SUPPLIER PROFITABILITY RATIO

1000 divided by ME-MD X SR X 100 = SPR

Example:

Margin Enhancement = $230,000.00

Margin Detraction = $110,000.00

Supplier Rating = 8

1000 divided by $230m-$110m X 8 = .066 X 100 = 6.6

This formula is by no means scientifically accurate. In fact, it is an arbitrary conception designed specifically for the exercise and not the result. The rating itself is not of significance here. What is significant is the exercise itself. It forces you to take a serious look at true vendor performance. List your vendors by their profitability ratios. This should be an eye opening exercise. Take this information and use it in your discussions and negotiations with your vendors. Be careful not to reveal all the details of your rating as it can be easily challenged due to the intangible assignment of various factors. However, it can be invaluable in discussing many supplier issues contributing to margin detraction.

What does a "stock out" really cost? How are missed deliveries impacting your customer’s service and lost business opportunities? Offer your suppliers an option, improve the ratio performance or increase discounts. Lastly when looking at Margin Improvement and increasing sales revenue a supply chain analysis is beneficial.

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