February 09, 2007

Running A Business Without Discipline

We frequently read about the importance of "managing the brand", about providing a great brand experience for the customer.

In the catalog/online world, it is just as important to properly manage the fundamentals of the business, the 'back of the office' execution that can make all the difference in the world.

There are several elements that all must be executed in harmony, executed efficiently, for the business to produce profit.

Fulfillment Rate: It should be no surprise that having the right merchandise available is an important part of meeting customer expectations. Too much merchandise yields markdowns. Too little merchandise yields lost sales. I spent my formative years at Lands' End. They were really good at striking that all-important balance.

Return Rate: Businesses don't have a lot of control over what is returned. For instance, the return rate on a pair of shoes is very high. The return rate of an iPod is probably a lot lower. However, businesses can take steps to reduce the return rate. Quality control is important. Using text to describe merchandise is important. Color-matching is important, so that the customer knows she is getting a 'lilac' dress.

Gross Margin: Closely related to fulfillment rate, gross margin is one of the most important profit drivers in a business. Gross margin is the difference between what the item sells for ($100) and what the item cost the business ($50). Markdowns are gross margin killers. Merchants who know 'what sells', and inventory managers who know 'how much to purchase' drive a lot of profit.

Pick, Pack 'n Ship Expense: Businesses should invest considerable effort in running an efficient call center and distribution center. Overstaffing either center results in too much expense. Inefficient ways to store merchandise result in added expense. This is an area that really good businesses focus a disproportionate amount of effort on improving.

When a business manages these areas efficiently, profit falls to the bottom line. When a business fails to manage these areas effectively, the business must significantly increase sales, in order to pay for its own inefficiencies.

In the table at the end of this article, one quickly notices that inefficiencies cause the business to have to sell nearly twenty percent more merchandise to achieve the same level of profitability. Think about that. When a business is run in a sloppy manner (the example below is not all that sloppy, by the way), customers need to spend twenty percent more just to help the business achieve the same amount of profit.

Leaders need to balance the importance of 'brand building' activities with the everyday tasks of running a business efficiently.

Profit And Loss Statement: Well Run Verses Sloppy Business

Base Case
Fulfillment Rate 90.0% $4,500,000 88.0% $5,151,960
Return Rate 25.0% $1,125,000 27.0% $1,391,029
Net Sales
Gross Margin 50.0% $1,687,500 48.0% $1,805,247
Less Marketing Expense
Less Pick, Pack & Ship Expense 11.0% $371,250 13.0% $488,921
Variable Operating Profit
Percent of Net Sales

Required Increase In Volume To Achieve The Same Profit: 17.1%


  1. Anonymous7:04 AM

    >Merchants who know 'what sells', and inventory managers who know 'how much to purchase' drive a lot of profit.>

    The tough part is, sir, that the merchants do not have an accurate idea themselves. I work for a supplier and merchants either give us very rosy projections, then leave us with tons of merchandise on hand, or else order way too little and then expect immediate replenishment as demand doubles or triples projection.
    In the first scenario, no one wants to tell the retail buyer don't order that much from us, it won't sell THAT well.When you receive a projection for $200k a month, and we know in reality demand will be less, do you really want to lose out on initial rollout?
    And in the second scenario, buyers don't listen, no matter how popular you tell them something will be, they are very cautious to the extreme. And then when rollout blows through they are looking for more today, but takes 30 days to produce.

  2. Those are good comments, coming from a multichannel marketing partner.

    How do you manage these manic swings in demand, while maintaining a profitable business?


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