How Do You Define Success In Distribution?

Start with margins, people and investment

Convention SpeakerWhich factor in wholesale distribution do you think is the best profitable indicator?

  1. Distributors with faster asset turnover?
  2. Distributors with bigger margins?
  3. Distributors with higher sales per employee?

Some distribution segments require a large investment in expensive equipment and other assets. Some industries enjoy larger orders and greater people productivity. There may be compensating factors from one trade line to another to balance the effects of lower margins, reduced productivity or slower-turning assets. The “levers” of distributor profitability are apparent when examining the strategic profit model, which compares return on sales, asset turnover and use of borrowing leverage. Data reported are industry averages for a recent year.

The biggest underlying causes of higher or lower return on sales are gross margin percentage and personnel productivity (which in turn has much to do with order size). The major factors behind asset turnover are inventory turns, receivables and required level of fixed asset investment.

This article focuses on three primary measures of distributor profitability: gross margin percentage, people productivity and required level of investment. The end result of the analysis is, of course, return on investment.

Gross Margin Percentage
The best database for distribution industry financial comparisons is the Performance Analysis Report (PAR), an annual industry survey prepared by the Profit Planning Group. This report is compiled for leading wholesale distributor trade associations and is the most commonly used benchmark available.

Warehouse gross margin percentage is the most effective industry indicator, because direct shipments (drop shipments) margins and agent sales margins vary widely from company to company.

Note the wide range of gross margin percentages in Figure 1. The higher margins are not necessarily indicators of a lesser degree of competition. They mostly reflect smaller orders, larger asset investment and/or higher levels of required service.

Gross margin percentage by itself is not necessarily a reliable predictor of high trade line return on investment (ROI).

People Productivity
There is a strong positive correlation between people productivity and return on investment percentage in wholesale distribution. In other words, distributors with more highly productive staff almost always make more money than their peers.

“Personnel Productivity Ratio” (PPR) is the best measure of people productivity. It is simply total compensation, including fringe benefits, divided by gross margin dollars. There is no place to hide low productivity from the PPR measurement.

The annual Performance Analysis Report includes the PPR for each trade line.

Note the wide PPR range among the trade lines. The ratio indicates the extremes in required service levels for the various lines, including sales and technical support as well as logistics. Remember that sales and sales support are the largest cost areas for most distributors. Also keep in mind the productivity challenges of small orders.

We rarely see a “top quartile” financial performance distributor with a weak PPR. Top quartile distributors enjoy a return on investment (ROI) percentage in the top 25 percent of companies in their trade line.

Required Level of Investment
The denominator of the return in investment calculation is owners’ equity, or the amount of capital the owners have invested in the business.

The table indicates the wide range of asset turnover levels among the trade lines in the study. While it is true that distributor management acumen often affects inventory turns, some trade line service levels necessitate very heavy inventory quantities.

Be aware that in some trade lines that traditionally require heavy distributor inventory levels, it is also customary for suppliers to provide extended payment terms to distributors.

Some trade lines require specialized storage and delivery equipment, processing equipment and/or a large distributor investment in equipment rented or loaned to customers (such as storage tanks or gas cylinders).

In a period of lower than expected interest rates, asset carrying cost may seem relatively insignificant. Heavy borrowing is still a distributor risk indicator that cannot be ignored.

Trade Line Assoc. GM% Warehouse order size People Prod. (PPR) Return on sales (pretax) Sales per Employee Asset Turnover Pretax return (ROI)
Electrical NAED 21.6% $446 60.5% 2.6% $505,000 3.2 17.4%
Industrial supplies ISA 24.5% $462 61.9% 2.3% $381,000 3.4 15.6%
Janitorial supplies ISSA 33.0% $406 64.8% 1.5% $275,000 4.1 11.6%
Fluid power FPDA 27.5% $753 63.2% 2.1% $389,000 3.5 14.0%
Gas & welding GAWDA 46.7% $168 56.7% 3.8% $199,000 2.0 12.2%
Printing paper NPTA 15.8% N.A. 57.6% 1.2% $852,000 4.3 13.4%
Source: 2004 Performance Analysis Report prepared by the Profit Planning Group in Boulder, Colorado.

    Gases and Welding Distributors Association

    Brent Grover Meet the Author
    Brent R. Grover is the founder of Evergreen Consulting, LLC, headquartered in Cleveland, Ohio, and at www.evergreen-consulting.com. His latest book is The Little Black Book of Strategic Planning for Distributors.