- The New Economics of Sales Growth
- By Dr. Albert D. Bates — posted 12/06/2011
Even after three years of somewhat stagnant sales growth, far too many businesses are still waiting for a return to a buoyant economy to get them back to the good old days of profitability. Sadly, those businesses are probably doomed to a very long wait. The "new reality" probably really is the new reality.
At the same time, the overwhelming majority of firms—including most ISSA members—have cut expenses to the point where there doesn't appear to be anything left to cut. Some level of additional sales volume is essential to generate desired profit levels.
These two conflicting realities—the lack of automatic sales volume growth and the fact that sales volume growth is essential to success—combine to put firms into a serious financial bind. In order to get out of that bind, firms must begin to look at sales volume in a different way.
This article will suggest that the sales growth required for success is readily accessible by looking at two different issues:
- The Sales Growth Requirement. This is an analysis of how to set a realistic goal for sales growth and its implications for the firm.
- Sales Growth Generation. This is an examination of the new requirements that are incumbent upon all firms to achieve high levels of profitability.
The Sales Growth Requirement
One of the most common misunderstandings about improving profit is that a rapid rate of sales growth is essential. The reality is that rapid sales growth is not essential; it simply makes life a lot easier. With just modest sales growth, it is still possible to increase profits. This should be excellent news for firms somewhat fatigued by a sluggish economy.
Please note very carefully that when there is no sales growth at all it is virtually impossible to produce higher profits; some modest level of growth is required. The challenge is in defining modest.
Exhibit 1 (below) examines the economics of growth by reviewing the financial performance of the typical ISSA member as reported in the latest ISSA Distributors’ Profitability Report (DPR). As can be seen in the first column of numbers, the typical firm generates sales volume of US$7 million, has a gross margin equal to 33 percent of sales, and generates a pre-tax profit of $105,000, or 1.5 percent of sales. Results are adequate, but unexciting.
The last two columns of numbers in the exhibit starts with one overwhelming principle: sales growth must at least equal the rate of inflation plus two to three percentage points. This is not arbitrary—it is the level that historical results suggest is required.
In this specific example, the underlying inflation rate is assumed to be 2 percent. Adding three percentage points to that rate results in a target sales growth rate of 5 percent. However, the two columns produce very different profit levels with the same exact 5 percent increase in sales.
Internally Focused Growth. In the second column, the sales increase has come from internal sources. In the simplest terms, the firm is selling existing products to existing customers. Such sales growth does not require additional staff in the short term. However, payroll increases almost always outstrip the inflation rate, so they are assumed to increase by 3 percent. In contrast, non-payroll expenses will be probably at about the same rate as inflation, or 2 percent. As a result, pre-tax profit jumps from $105,000 to $161,000, an increase of 53.3 percent.
Externally Focused Growth. The final column assumes that the sales increase is generated via external sources, namely new products and/or new customers. Research conducted by the Profit Planning Group across more than 100 lines of trade for over 30 years has demonstrated that that the reliance on such sales sources produces a significant increase in expenses.
The last column assumes that payroll costs increase by 7 percent and non-payroll costs increase by 3 percent. Again, these are consistent with historical patterns associated with external sales growth. The result is that sales increase by the same 5 percent as in the second column, but profit actually declines by 11.7 percent.
The challenge is that in a slow-growth market every firm is looking for external sales growth. There is a feeling that the market is not growing fast enough to support the required growth goal of inflation plus two to three percentage points. In fact, virtually every firm can capture such growth with a structured effort.
Sales Growth Generation
Obviously, growing sales by even a modest 5 percent when the market is only growing by, say 2.5 percent, is far from automatic. However, it is a goal that can be reached by committing to these three specific strategies.
Letting Inflation Work. Over time, prices head north in all but a very few unique industries (think consumer electronics). Vendor price increases are actually the ISSA member's best friend. Unfortunately, they are almost always viewed with disdain if not outright contempt.
In a tight economy, the problem is that firms are tempted to absorb a portion of supplier price increases. Instead, there must be a mentality in the firm that every 2 percent price increase from suppliers must result in a corresponding 2 percent price increase to customers. This will usually keep sales growth in line with inflation. That still leaves 2 percent to 3 percent to cover to get to 5 percent growth.
Controlling Internal Economics. Growing faster than the inflation rate means the firm must begin to gain share. This is where the internal focus becomes absolutely critical.
Increasing the average transaction size, largely by adding more lines to each order, is the essence of an internally-focused sales generation strategy. By definition, if the firm can put more lines on every order, competition is getting fewer of those lines.
To fully implement the strategy, the firm must measure, monitor, and control the average order size and the number of lines per order. Without such a measuring system, improvement cannot become a reality.
Sales Force Discipline. In a rapidly growing market, firms can allow under-performing salespeople to stay with the firm for the sake of employee morale, team spirit, and the like. In a slow-growth market, poor-performing salespeople are a luxury that can no longer be afforded.
Sales training must be emphasized. Coaching and changes in compensation systems (e.g., lower base salary, more incentive compensation) also are essential. Ultimately, if adequate sales can't be generated, a change in personnel must be considered. Finding and training a new employee is an expensive proposition, but keeping an under-performing one is even more expensive in terms of sales and margin not generated.
Automatic increases in sales fueled by a vibrant economy are not going to be a reality anytime soon. Firms must develop ways to turn slow sales growth into rapid profit growth. Doing so requires a commitment to focus much more heavily on internal sales growth.
Dr. Albert D. Bates is chairman, president, and founder of the Profit Planning Group, a research and executive education firm headquartered in Boulder, CO, that helps small to mid-size companies understand the financial side of their operations. He can be reached at firstname.lastname@example.org or visit www.profitplanninggroup.com.