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Venture Partners

Profit Enhancement






Profit Enhancement for
Transaction-Intensive Businesses


Many of our clients are in transaction-intensive businesses. In such businesses, the processing of customer orders is a large portion of value added and a critical success factor. Classical transaction-intensive businesses include wholesale distributors, resellers and mail order vendors. Many other businesses have transaction-intensive operations, e.g., suppliers of computer parts, software products, medical disposables, etc.

In transaction-intensive businesses the potential for profit improvement frequently exists but is typically difficult to realize. Straightforward cost reduction or price increases are seldom sufficient to increase and sustain overall profitability. At the heart of the problem is the information upon which most profit enhancement decisions are based: gross profit per product.

Gross profit per product is helpful to management and convenient to obtain, but woefully insufficient to drive profitability. Cost of goods sold is typically a given. Price levels can be managed, but they vary with external factors such as competitive pressures, customer-specific terms, and channels, all of which are hard to control.

Effective profitability enhancement actions stem from improving the gross profit dollars per order, and per customer, more than per product. Gross profit per order is typically the most responsive and the easiest to increase and thus is the focus of the following discussion.

Importance of Order Size
There is a clear correlation between profitability and the management of order-related economics. Within the context of the existing business mix, re-engineering order costs may improve long-term profitability. Nevertheless, significant, short-term improvements can be realized by managing order size. Generally, the larger the order, the greater the gross profit dollars form that order, even adjusting for volume discounts (see Exhibit A).



Exhibit A

TRANSACTION ECONOMICS





Cost per order, on the other hand, is predominantly volume independent. The time (and therefore cost) incurred as large orders are received, entered, picked, packed, shipped, and invoiced is roughly the same as the time to process a small order. Accordingly, in many businesses one finds overall profitability improves with increases in order size.

Exceptions to the general rule typically reflect the influence of three factors. First, as many transaction-intensive companies grow they tend to experience proportionate rises in complexity, e.g., number of SKUs, number of suppliers, added service benefits, etc. Increased complexity can lead to higher transaction cost levels as the organization works to have the business perform in accordance with increased customer expectations. Second, just-in-time inventory purchasing patterns of some customers make fulfilling small orders a prerequisite for doing business. Third, differences in gross margin due to variations in product mix across customer types can blur the underlying order size-related economics.

Increasing Order Size
Considerable leverage over profitability can be achieved by increasing order size, which, in turn, increases profit per order. Curiously, few transaction-intensive companies attend to this key variable.

The first, and critical, step to increasing gross profit per order is simply to track the statistic. Track average gross profit per order by customer, channel, product line, sales person, and location. The range around the corporate average for these various metrics is often dramatic. Arraying a company's customers on a grid, as shown in Exhibit B, will reveal that the best customers are those with high gross profits per order, not necessarily those with high annual sales volume. Sales force performance can be arrayed in the same manner. Some sales representatives, despite the fact that they meet quota every year, may be "giving away" the company's profits by allowing numerous small orders.


Exhibit B

ACCOUNT STRATEGY





Alternatives for changing the behavior of the sales staff and customers include:

  • Making it clear that gross profits per order is a key performance variable. Collect and report the success/trend for each sales person.
  • Training telesales staff and field representatives in techniques which "build" order size.
  • Compensating the sales force for improvements in order size.
  • Setting/enforcing order minimums, thereby insuring improved economics.
  • Linking key customers to your operations/warehouses by computer.
  • Providing incentives to customers to build orders, not simply build annual volume.

As order size increases and higher gross profits per order are generated, the overall profitability achievable with existing capacity will have increased. If the business is stable, capacity can be reduced. If the business is growing, it can do so without having to add proportionate support costs. Performance benchmarks can be established to insure that the benefits of increased order size are realized as the level of business activity increases.





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