9 questions on margin management

1)    What margin management means to you and how it is related to pricing or procurement in a company?

I see margins management under two perspectives:

i.    The sustainability of the business model: A retailer proves its reason for existing by being approved – found relevant - by its suppliers and its customers. The gross margin obtained will be resulted from how much the customer is charged (and the customer accepts being charged when it decides for bringing its business to a certain retailer) and how much is spent to make the product available to the customer (an important part of this cost is paid to the supplier). If the resulted margin is insufficient to cover for the spending involving expenses, investments (infrastructure) and the remuneration of the financiers, a red light turns on and one must question if the problem is one that involves the sustainability of the business model. The balance of the business model resides between what is delivered, what is spent to deliver it and how much is charged for what is delivered!

ii.    Execution of the margin management: What is the understanding of and the degree of influence in the formation of costs (procurement, logistics, taxes, ‘total cost of ownership’); how selling price is formed (pricing); and the degree of knowledge about our customers and suppliers.

Large retailers have a Pricing department are whose main role is that of providing intelligence and support to the commercial and operations areas. Pricing considers two dimensions: product and store (channel). At product level the possibilities are: a) category role (traffic, routine or margin) and b) EDLP or Hi-Lo. At store level pricing can be per store or cluster.
There is a need of working with “automatic margin” to the bulk of the assortment combined with a small parcel (of the assortment) being priced by the buyer and by the store.
 

    


2)    What is your experience of working with tight margins in a sector in which competition announces promotions on a daily basis. In such an environment how manage margins?

The first step is to understand the columns that sustain retail (or distribution). These columns are: (1) Scale (offering-scope; volume-depth); (2) Efficiency (simplicity, consistency, repetition, automation and transference of activities to the customer); and (3) Management (detail: cash, spending, margins). And also guarantee that these columns are disseminated throughout the whole organization (front office and back office). It involves forge a mentality, a basis for reasoning and decision making.

The second step is that every commercial manager (buyer) has clarity on the role of the categories under responsibility (traffic, routine and margin). Product categorization is very important as a cash and carry works with 12-15 thousand SKUs, a supermarket between 25 and 35 thousand SKUs, and a hypermarket with 35-60 thousand SKUs!

The third and last step is to offer (agile and flexible) tools that help in the analysis, decision making and monitoring:  assortment matrix; automatic pricing system; Sales and Margins per category and product; Supplier Scorecard; Price Shopping etc...  
 

    
3)    Competing may cause margin deterioration, mainly if a competitor is trying to gain market share. What is the strategy to adopt to avoid losing market share and keep a good profitability?

One does not compete solely based on price, but also on location, assortment, customer car and offered services. It is, however, close to impossible to engage in a competition without sacrificing margins. A few strategies adopted for the short term to force an accommodation are:

Follow on: Increase the promotional activity with the support of national suppliers (making use of buying power);
Escalate: cut prices across the board, scaling up competition;
Increase the losses of the competition: identify the products discounted by the competitor and that are in large quantities and cut the price of these products, announcing them on the media, however without having them in quantities (the objective is to make the competitor bleed not you!);
Invest on communication; and
Remodel: change layout, assortment, and signage to create a new fact to attract back the customers.
 

4)    In a public company how to manage the anxiety and questioning in regard to released gross margins?

During a part of my career I was a CFO and Investors Relations Director for a public retailer. When releasing quarterly results we tried to be as clear as possible in regard to any margin deviation. Our understanding was that if the company could show clarity on what was happening with its margins, it would demonstrate to be in control. After all, margin is an indicator followed up closely and given to its relevance leads to analysis and conclusions that may affect importantly the value of the business. If the margin is falling it may indicate sacrifice (to sell, increased competition) and an increase in risk. If margin is high, it may indicate that a higher market share could be captured or yet a risk of entering a new competitor.

 

5)    Imagine that you are in the Board of a company. What would be your recommendation to the management in regard to margin management?

In fact, this is something that we already do to companies we offer Advisory Board services. I will give a specific current example involving a consumer goods manufacturer where we are challenging the distribution channels.

A big challenge to consumer goods manufacturers is related to the margin management of sales channels. Big retailers offer volume, regional or national distribution; nevertheless, in exchange they offer a lower margin and a higher cost of serve. Distributors, demand credit, what represents an unacceptable risk in the moment we live in Brazil. Furthermore, in the case the portfolio of products offered by the manufacturer is limited; getting attention from the distributor is difficult. After all they sell what is easier! The identification and search for other sales channels such as specialized stores or corporate became important. This search for new channels considers, besides margin, logistics costs and working capital commitment.
 


6)    In relation to strategy, what you consider more relevant to margin maximization: product mix, client mix, price negotiation or spending reduction?

All these elements are important. What is done is to find a combination of them all:

a.    Revise and revisit assortment: periodically, at least once a year, the assortment must be evaluated in relation to its contribution to sales and margins. Also having in place an Assortment Committee responsible for the introduction of new products (“one in – one out”) is important;
b.    Acquire customer knowledge: periodically a research is conducted to understand the purchase motivation, the reason for choosing a given store, what are the elements valued in terms of assortment, price and customer care, perishables and competition;
c.    Revisit the assortment cost: break down the cost of the product: input, workforce, production, distribution, logistics, taxes, financial cost. This is made for the more relevant products. Also another method for an extended number of products is to estimate the suppliers price list based on the selling price in the competition (taking into account an estimated margin).
d.    Expenses management: the existence of a periodic budget; a close expenses management discipline; along with an authorization process prior to incurring on the expenses-spending.
 


7)    Considering the existing competitive environment, how is possible to innovate in applying margin management and how to promote a culture that makes use of it as a strategic tool?

In the day-to-day of big retailers, margins, spending and working capital are core in any discussion. The three elements are interrelated. Gross Margin is linked to three main things: how much is paid for the product that will be resold; how much cost to put the product at the shelves; and how much the customer is willing to pay for the product. Spending is linked to the offered service level, involving the building where the store is, its maintenance, the number of employees to operate it, etc. Working capital is associated to the payment terms to suppliers, to sales turnover (stock turnover) and the payment terms offered to customers. The existing systems in place must allow monitoring, in real time, all this: sales, taxes, cost of goods sold, working capital and expenses.
There are, yet, important discussions in place involving the role of the physical retail in the coming years that will importantly affect margin management: (1) the substitution of sales for rent; (2) the substation of sales for service fees (model in which the supplier will fund the operation cost of the store and pay an administrative fee). These models may be in a distant period, however, they are likely to start impacting the income and margin of retailers, once its growth and materialization tend to be gradual...

 

8)    Have you had the experience of the outputs received from the margin management altered the company’s strategy?

A few examples experienced in cash & carry wholesaling: (1) refocused sales channels (store-telesales-corporate-delivery) favoring the more profitable channels store and delivery; (2) refocused on transformers (Hotel, restaurants and caterers) and service providers customer groups in detriment of resellers; and (3) in the beverages categories changed focus to brands with better margins (this is done not by eliminating the brands with lower margins but simply keeping them at the suggested price and promoting and giving more space to better margins brands). In another example involving a non-food retailer (specialized stores), we concluded that the retail business would not be sustainable operating stand alone and we integrated it into a distribution organization, combining distribution and retail margins (moving the retailer upstream). In another example involving a non-food retailer we concluded that the challenge resided in: reduce margins of the slow mover assortment (by reducing selling price) to improve overall margin mix and, also, work in the reduction of expenses.

More recently in a consumer goods manufacturer we are discussing margins in two dimensions: channels and clients. We are analyzing the direct gross margin and also the cost of serve (merchandisers, promotional bonuses etc). This is leading us to wonder if the channels strategy in place should be changed. One initiative already in place is a commercial and distribution agreement with another manufacturer (complementary assortment). This agreement will make possible increase the distribution reach!

 

9)    What are the difficulties faced when implementing margin management?

The existing logic for implementing any project is there: defining a model, identifying necessary resources and systems, implementing, training, measure results making the necessary adjustments.
In my own experience the problem resides on the search for perfection or for aiming the maximum. As a result precious time is lost in the identification of more adequate resources and systems. In fact, better is to initiate with the available resources or those that can be obtained and “pilot” the project. It is better to be a protagonist rather than the best since the beginning!