Improve margin via the back end

Why do many multichannel merchant start-ups struggle? To grow they need to price competitively; their fulfillment costs quickly accumulate; and their actual gross margins drop. Companies expecting to earn at least a 35% margin will often see it drop to the low 20% range.

Does that mean a 35% margin is out of the question? No, but you may need a profit-financed growth model to get there.

The benefits with this model are clear: You keep the business, your spending is conservative, and because of financial constraints, your focus is like a laser.

But this model comes with a few challenges: You must watch cash carefully, make sure your profit-and-loss numbers are accurate, and your team will need to be intimately familiar with best retail and fulfillment practices.

Each product category has its specifics, but there are some universal rules. Here’s my recommended battle plan; start with this and tailor it to your needs:

  1. GET THE REAL NUMBERS

    Do you trust your own financial statements? Or do you constantly fight with finance about the “plugs” and “true ups” commonly known as accruals? There are multiple reasons why costs lag the sales, and monthly reconciliation is the only way to get accurate financials.

    To get to the bottom of things, follow these steps. Yes, it’s painful and time-consuming — but necessary.

    • Export the last nine months of costs from QuickBooks or any other system you are using with maximum details available to link each cost to an appropriate purchase order.

    • Discard the three most recent months, as they are likely to be incomplete (no return, reship, backorder costs etc.).

    • Clean the six months of data, use “purchase order,” “sales order,” “customer name” or “address” to link costs to the purchase orders.

    • Split cost of goods sold and freight. Your accounting practice has been to enter a single amount for COGS and freight? Well, hire an intern to scan all the paper invoices — and a team in India to convert the PDFs into a gigantic Excel table with purchase orders, COGS and freight numbers.

    • Once the information is clean and on the PO level, use a pivot table to accumulate all freight costs for multiproduct or multibox orders.

    • Extract sales numbers on the sales/purchase order from your order management system. Make sure you export order statuses as well. It will be interesting to see the costs associated with your cancelled or returned orders.

    • Use the VLOOKUP command in Excel to match costs with sales numbers

    • Calculate freight as percentage of retail (order freight dollars divided by [order retail dollars + freight retail dollars]), COGS as percentage of retail (order COGS dollars divided by [order retail dollars + freight retail dollars]) and gross margin on the vendor level.

  2. IDENTIFY THE BIGGEST OPPORTUNITIES FIRST

    Now create a list of all the vendors with COGS more than 55%. Supply your category managers with sales and costs for the six months. Have them speak with the manufacturers and explore better discounts.

    Make another list of vendors with freight more than 15%. For each of them, calculate “freight savings opportunity” (actual freight – sales × 0.15).

    Then call 10 vendors with the biggest potential savings and learn about their shipping contracts and product specifics. My bet is that your “worst offenders” will have 15% to 20% discounts on UPS/FedEx and 65% to 70% discounts on less-than-truckload. You can do better!

  3. PICK UP LOW-HANGING FRUITS

    Reducing your shipping costs, in my experience, is the fastest way to get to the magic 35% gross margin number. Let’s say your freight is 20% of sales. Manage it well, and the number drops to 15%; do it exceptionally well and your freight will be 12%. Can you think of any other area that can add 8% to your gross margin?

    Working with shippers is always quid pro quo. You give them a lot of new business; they give you exceptional discounts. How do you get the best prices in shipping?

    • Calculate your annual small package, LTL and “white glove” delivery spend. Understand requirements for expedited delivery, your customer geography and product characteristics.

    • Present your local sales reps with an opportunity to build a $500,000, $1 million, etc., account in X months. Share your shipping details with them; be upfront about discounts you are looking for.

    • Get multiple offers, compare rates and ask shippers to beat the best offer. Repeat. Select the two best guys in each category.

    • Convert a few vendors with highest historical freight/sales numbers to ship on your accounts with preferred carriers. Run a pilot, calculate actual freight/sales.

    If for some reason, say, unexpected charges, your costs are still high, renegotiate. Remember, even if negotiation takes two to three months, you’ll be enjoying the benefits for years to come. Invest heavily in data analysis and contract negotiation.

  4. IDENTIFY AND ATTACK SECONDARY TARGETS

    Accurate financials will suggest what area you should focus on after COGS and freight. For instance, you should check your cancellations.

    It’s not unusual to have a 10% cancellation rate. It’s also frequent to have just a few merchandise vendors responsible for these cancellations because of long delivery times or backorders.

    Contact them weekly and your cancellation will drop a few points. You should also record returns damages and other fulfillment costs separately from your other orders.

    And perform monthly reconciliations. Accurate numbers convert into better processes and higher margins.

  5. CONVERT KNOWLEDGE INTO SALES

    Once you are comfortable with your numbers and efficiency you can take it one step further. Here are three tactics to consider.

    • Integrate actual costs into pricing decisions. Recalculate margins based on actual costs and find products with “excessive margin.”

    • Compare your retail prices for those products against those of your competitors.

    • Run an experiment: Pass your savings on shipping to your customers in the form of a reduced sales price or free shipping. Promote repriced products through price comparison engines such as Shopping.com and Bizrate.com, and compare sales/margins per product with results from previous weeks.

    In my experience, you can increase sales tenfold by offering products for $5 to $10 less than your competitors.

Reaching 35% margin is possible — even during the recession. All it takes is good people with data crunching and negotiation skills. Sometimes you already have them on your team; other times you need help. Look around; there are many ways to find experts. LinkedIn is a good networking resource, Google search is another.

You will be amazed at how much can be achieved in three to four months. Your costs go down, business becomes more transparent, and you are again driving the car — instead of watching it lose oil every mile.

Maxim Mironov (max@optimalogica.com) is a supply chain expert and founder of e-commerce fulfillment consultancy OptimaLogica.

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