How To Grow Profits AND Shrink Assets In a De-leveraging Credit Crunch World

The deflation of the global, credit bubble and all of its subsidiary bubbles – housing, auto, emerging markets, derivatives, etc. – are causing banks to de-lever. This is sure to add to the length and depth of the current US recession, and to a decline in sales for most distribution companies.

Most distributors with working-capital lines of credit will find that those loans will become more difficult to roll over and/or more expensive. For leveraged firms with low pre-tax return on assets or with the slightest credit-line infractions, the immediate goals should be: to increase free cash flow for paying down debt from both higher profits and lower sales which will reduce investment dollars in inventory and receivables.

The debt-free firms that can build additional cash positions will have opportunities to acquire assets from and fill vacuums of over-leveraged competitors that implode from called loans. This is already happening in the housing-industry supply channels. My guess, however, is that company valuations – averaging across all distribution channels – will continue to drop until a few months before housing prices finally bottom out. (The Case-Shiller housing futures index currently forecasts the bottom to be around June 2010.)

How can a distributor increase profits when profits normally go down in recessions, especially long ones? The unique pathway for this paradoxical objective can be found in the comprehensive use of customer profitability ranking reports that are built on good, activity-based-costing (ABC) models.

If the average distributor makes roughly 150% of its profits on the top 40% of the accounts to cross-subsidize the bottom 60% of the accounts that lose 50%, then there are a number of profit improvement plays that flow from and can be guided by such reports.

From many, first-hand, case experiences, I’ve seen profits increase 2 to 3 fold while sales dropped negligibly and inventory turned faster (freeing up more cash) by using customer profitability reports to rethink business assumptions, tactics and incentives.

What are the obstacles that have kept most distributors from thoroughly exploring, if not pursuing, the renewal path that is guided by customer profitability ranking reports?

  1. Lack of in-house expertise. Most firms aren’t sufficiently knowledgeable at: understanding this new way of thinking: developing effective ABC models, and then interpreting and using these reports to run unfamiliar plays. Wouldn’t it be great to be able to rent this talent on an outsourced basis only as needed?
  2. The existing, in-house information system doesn’t fully support the measurement and improvement of all of the “true, profit-power growth factors”. This is because ERP solutions are designed to: support functional activities; pay right taxes on time; and support asset-backed lending from banks. After struggling to do GAAP reporting on a timely, accurate basis, where do we get the resources to create and maintain a second reporting system for measuring and improving profit power processes and metrics? Standard “business intelligence” modules that slice GAAP data infinite ways generate info-glut and still tell us nothing about: customer profitability; the elements of the people-service-profit chain; and other profit-factor levers.
  3. Re-education-ware: Even if all of the new reports and answers were presented to us on a platter, how do we teach all of our employees to think and behave differently to grow profit power instead of pursuing profitless, sales-volume from too many growing nowhere customers and too many, now-not-turning dead items in inventory? Where can we get an affordable, high-performance, profit-power-growing curriculum that supports a profit-power reporting system?

The answer to all of these why-don’t-we-do-it questions is to – at least initially – outsource the problem to a focused-pro, just as many firms have outsourced their payroll to Paychex. I have recently partnered with a firm that uses: new database technology; many different, specific-to-distributor, ABC models; and on-demand, remote storage to produce all of the reports that a distributor needs to better measure and improve the true sources of profit power.

This software-as-a-service (“SaaS”) solution provider can take all of a distributor’s financial data, as well as daily, hand-gathered and inputted data from front-line employees, via the internet. This data can then be recast into a strategic, profit-power reporting system for each profit center. The bottom-up detail data can then be consolidated across all profit centers of a chain to maintain a real-time view of how ever-improving employees are delivering ever-improving service value to better retain and penetrate the most profitable customers. The base cost for setting up the system and the monthly maintenance fee will be about 20-25% of the first year’s increase in profits and put users on a high-performance path that will assure 12 to 15% pretax return on total assets ever after.

I like the potential of this service so much that I have offered to round up a diverse group of proactive distributors to help make this total service offering even more robust. My new partner and I are currently planning to host a one-day seminar at an airport hotel in Phoenix on November 13th from 9:30 am to 3 pm (for the fly-in and out participants; we’ll stay as long as others might like).

This is an invitation-only event that involves a nominal overhead cost fee ($100) and you may bring (or send) anyone you wish from your team. If you’d like more details, please contact or call me at: 919-357-2372.

If the date or location doesn’t work for you, but you are interested in learning more about the solutions to the credit crunch imperatives, let me know. I will continue to write about solutions to these challenges, and we may run more seminars in more cities.

©Merrifield Consulting Group, Inc., Article 1.22

October 15, 2008