Profit Leaks and How to Fix Them

This is a strange economy. Sales may be gaining momentum but in many cases, it seems that fat is beginning to creep back in to many organizations and tamping down profitability. Profitability can be elusive, and the level of profitability depends on how well the business is managed.

We will spend a bit of time on common sources of profit leakage and strategies to address those leaks and plug the holes.

What Causes Profit Leaks

There are many contributors to profit erosion in an organization. On the indirect expense side, you should keep an eye out for the following that is probably occurring in your organization right now.

1. Supplier Price Creep

Many suppliers are pushing through price increases. Most are honest enough to give you some warning ahead of time, but others slide the increases through on the invoices hoping that you won’t notice. Some may not change pricing at all, but begin playing with inventory levels (uniform programs) and reducing package quantities while charging the same prices.

2. Fire-Fighting Mode

Because staffing levels are thin in most organizations, many organizations don’t have time to source correctly. Tactical purchases with a focus on short term pricing at the item level is very common…this is commonly referred to as “fire-fighting or the “get it done” approach. The task may get accomplished for today, but unless prices and terms are locked, chances are that prices will be increasing soon and the effort spent sourcing this time will have to be repeated in the months to come. This can result in a considerable waste of internal resources and time.

3. Supply Base Explosion

There are thousands of suppliers out there who can’t wait to sell you the next big thing and at very competitive prices. If your organization is prone to adding a new supplier because they can sell you a couple of items at better prices than you pay today, your supply base is probably growing. With that, the amount of invoices that must be approved and signed off and the checks to sign are likely growing, which is dragging down your back-office efficiency and costing you more than the few cents you saved to begin with. Chances are the AP staff is buried and trying to keep up. If so, you are experiencing a supply base explosion. Remember….you probably have 120 expense categories in your dealership…….you don’t need 400 suppliers to support your business and it is expensive to add suppliers to sell you a couple of items that are ”value priced”.

4. Partneritus

Suppliers who are partners to your organization can be a very positive aspect of your business. They understand your needs, service you when you need it, provide high quality products and services and charge you a fair price…..not the best price, but a fair price. As a Purchasing professional, I respect suppliers and the partnership approach that many enjoy. My advice on supplier partnerships is to enter into those relationships where they make sense and with suppliers you trust, but then apply the Ronald Reagan principle of “trust, but verify”. Verifying supplier pricing periodically through an RFQ process makes sense……even with partners. It is amazing to me how many long-standing supplier relationships we see where pricing is 20-30% higher than market. While partnerships should result in fair pricing to the supplier, a delta of 20-30% seems over the top for a relationship built on long standing relationships and trust. How much is that partnership worth?

5. Supplier Duplication

How many suppliers do you pay for the same service? Look at your DMS service and your digital marketing suppliers and you will likely find over-lap in services you are currently buying. A detailed review of your marketing suppliers will probably yield the same result. There are roughly 40-50 expense categories in the marketing side of a dealership business. If you have 50-60 suppliers which most organizations do, then you are probably experiencing some level of profit leak from duplication. How many suppliers sell gloves and hardware to your organization? Do you really need that many? Duplication should be investigated and rooted out on a regular basis with you management team.

6. Contracts

Much has already been written about managing contracts effectively, but most organizations seem to be in denial about this issue. Most Dealers will tell you that they don’t enter into contracts and they don’t have any to manage. The truth is much different in most cases….contracts do exist and I would venture to guess that most organizations have as many as 20 supplier contracts that if not managed effectively, will auto-renew and bring automatic price increases with them. Not only are you stuck with a price increase, but you are now locked in for another 3-5 years of an uncompetitive agreement. Gathering up contracts, tracking them against expiration dates is pure administrative work and not very exciting…..but on the other hand, learning that a contract just auto-renewed for five years at a 5% increase in pricing per year is not an enjoyable event either. One costs much less than the other.

7. Reliance on Internal Benchmarks

Many well-intentioned managers relish an opportunity to renegotiate with suppliers, but are usually poorly equipped to do so, and most only do so every three or four years when the contract is up. They grab the previous agreement or price sheet and then begin a process of negotiating with the supplier to reduce current pricing, or at least reduce the amount of the increases slated to occur. If the only source of your benchmarks are internal and you work from that position with a supplier, you will probably end up paying too much. There are plenty of sources to obtain good quality benchmarks in every expense category….but it takes effort…and a bit of creativity. The better approach is to go out for quote to a number of suppliers, but absent that, obtaining a broad and deep set of benchmarks is the next best approach, and far preferable to using internal pricing benchmarks.

How to Stop Profit Leaks

There are plenty of opportunities to stop the leaks and improve your profitability. The question really centers around how important that objective is to you and your management team. If you and your team are serious about improving profitability through improved operational management, the following strategies should be considered and implemented soon.

1. Set an Aggressive Profit Objective

A written objective has meaning, and it has even more meaning when it is shared, communicated and tracked with your team. The objective can be set in dollars, % improvement, cost reductions achieved, etc.

2. Audit Your Invoices

 A regular review of invoices looking for price increases – comparing current invoices to previous invoices, should stop the bleeding that can occur with supplier price creep. Auditing high cost expense categories should be a regular part of your management strategy. Once suppliers know you are auditing and holding them accountable, problems seem to diminish quickly.

3. Staff Your Purchasing Function

Spending 4% or more of your total annual sales on supplies and services should deserve your undivided attention and your best efforts. Assigning purchasing responsibilities, the commitment of valuable company resources to personnel with little time and little training is analogous to doing the same thing with your Human Resources or Legal function. You would never assign those tasks to untrained resources because of the potential risk and cost to your organization. The same should be true with your purchasing responsibilities. An effective internal Purchasing resource should pay for themselves and much more….a low risk proposition which will also reduce your organizational risk and quickly add to your profitability.

4. Quote – Quote – Quote

Organizing your purchasing function, and quoting your categories on a regularly scheduled basis will bring sanity, calm and improved profits where chaos, confusion and increased expenses previously reigned. Partnerships should be developed where possible, but checked and verified against the market periodically. Quoting reflects “truth” in the marketplace…..and your improved results will also show up on your bottom line.

5. Manage Your Contracts

Some suppliers hope you remain disorganized and miss your auto-renewal dates. That is why they insert those requirements into the agreements in the first place. Rarely do suppliers come to you and offer up that the contract is up for renewal in 90 days and they want to begin discussions. No, they hope you forget about the agreement and hope you become tied in for another extended period and are excited that their new price increases will soon go into effect. That is the reality. Only your willingness to organize your agreements, track and manage those agreements will stop this source of continued profit erosion and frustration.

Final Thoughts

If you are looking to improve your own profitability, do the calculations……the result can be an impressive contribution to your bottom line. Look at it another way….how many vehicles do you need to sell, how many parts do you need to sell or vehicles do you need to service to add that same amount to your bottom line?

The answer is in front of you……increased profitability is attainable…….solutions have been identified……what is your next step to improved profitability?

If you are planning to undertake this effort to get your spend management function set up and running correctly, you do not have to go it alone. StrategicSource’s Profit Improvement program help you identify areas for improvement long-term.