Gross Margin: Your Key Profit Driver

In our last article, we took a macro trip through the ratios and the road map to demonstrate the Profit Mastery process. (See “Rx for Survival,” JCK, March 2004, p. 76.) This time we’ll use the same road map to drive deeper into the gross margin (GM) issue, because it’s one of the two key success drivers in the jewelry industry. So, let’s focus on gross margin—how to measure it, how to manage it, and how to improve it. In order to take positive action in any situation, you need to know three things: where you are, where you want to go, and how to get there.

Measuring gross margin is relatively easy. Simply subtract your direct costs from your sales. Direct costs are your cost of product or cost of goods sold (COGS). Express the resulting figure in dollars, and we’ll call it gross profit. Express the resulting figure as a “percent of sales,” and we’ll call it gross margin.

A quick study of the road map tells you that if it doesn’t get to the gross margin line, it won’t get to the bottom line. This is crucial—for two reasons.

First, you have to know how you stack up to others in the industry (i.e., where you are). How does your GM compare to that of others—to the median (or half-way point) and to the top performers? An understanding of industry standards will allow you to set goals (i.e., where you want to go). This is called “benchmarking,” and without it, you have no clear management target.

Second, and most important, once you have a goal, you’ll need to formulate an action plan of how to get where you want to go. This is where the road map becomes an invaluable tool—by allowing you to progress from the “low gross margin” symptom to identify “causes.”

On the road map, we’ve highlighted the seven primary causes of a low gross margin. They are:

  • No cash discounts on payables

  • Low productivity

  • Poor inventory control

  • Shrinkage

  • Bookkeeping errors

  • Poor buying

  • Poor pricing.

No cash discounts. Clearly, not taking discounts results in paying more for the merchandise. Not paying within 10 days on a 2%/10/N30 invoice can result in significant lost margin dollars, because you actually pay more for the product. For example, a lost 2% discount on $100,000 COGS translates into $18,000 in lost margin dollars!

The answer? Take your discounts! And don’t be afraid to ask for one if it’s not offered—or ask for a bigger one even if it is offered. The worst the vendor can do is say “no.”

Low productivity. This typically refers to “people” productivity. If you do a large percentage of your business in design and/or manufacturing, you’ll want to look at some comparable benchmarks from your peers in this area.

Poor inventory control. There’s much more to be said on this topic in a future article; however, there are really two components to the inventory control issue: 1) having the right dollar value invested and 2) having the right product mix.

Having too much inventory creates the “hidden costs” that accountants tell me add up to 2% of the excess per month—or 24% per year. This includes items such as interest (if borrowing is required), lost discounts, handling, obsolescence, taxes, breakage, and space. If you have an excess inventory worth $160,000 … well, you do the math!

Shrinkage. Shrinkage takes two separate forms in most businesses: waste (of raw material from a production process) and theft.

Who steals? Everybody, but mostly employees. What will they steal? Anything—or everything. Again, we’ll cover this more carefully in a future article. For now, after you’ve reconciled the other six components, chalk up to shrinkage the difference between the calculated inventory that’s on your financial statement and your actual physical inventory.

Remember, a fortune in precious stones and metals fits in the palm of a hand.

(Note: Have you ever discovered customers or employees stealing from you? If so, e-mail your stories to me at lefever@brs-seattle.com, and I’ll consolidate them into a theft checklist to be published in a later article.)

Bookkeeping errors. Over the past decade, accounting systems have improved so much and are so affordable that there’s now no excuse to settle for anything less than a first-rate system. Accounting systems will be evaluated in a future article.

However, remember this: Computers generally don’t make mistakes—people do. You need accurate, timely information, so if you can’t do a good job with an affordable in-house package, you should go to an outside person—preferably a CPA—who does it for a living.

Even if you do have an internal bookkeeper, it’s not a bad idea to have your statements reviewed on a regular basis by an outside CPA. Either way, don’t choose a CPA who’s so busy with his or her tax practice that you can’t get regular statements (or get your internal statements reviewed) for the first half of the year.

Poor buying. If you’ve ever tried to visit every vendor at The JCK Show ~ Las Vegas, you know it’s an impossible task. Most of us don’t have that kind of mental, emotional, or physical stamina. Furthermore, what you pay for an item is a function of many things—volume, terms, popularity, vendor supply, etc. Much like buying a plane ticket, buying jewelry means confronting an endless number of price points.

To deal with this daunting task, store owners try a variety of tactics. Some buy whatever’s cheapest, some narrow it down to a manageable group of vendors integrated to both their market and their merchandising plan, and still others choose to outsource through a buying group.

No matter how you slice it, it’s a huge task. However, an ineffective strategy can cut 1%-3% off your GPM, and in a $1.5 million store, that’s no small deal—you could be losing $15,000-$45,000. The moral: Don’t go to any buying show without a detailed purchasing plan. And once you’ve got one, stick with it! We’ll address this topic more in later articles as well.

Poor pricing. If I buy an item for $1 and sell it for $2, that should be a 50% gross profit margin (GPM). So, how could I come out with a 42% GPM?

I suspect the culprit is not so much the initial pricing as it is the discounts that are given. Here’s a suggestion from Colin Pocklington, CEP, JGMB (an Australian buying co-op): Instead of giving a 5% or a 10% discount, deduct a specific dollar amount (a lesser percentage). For example, on a $900 item, offer a $60 discount, not 10%. Remember, a 1%-2% impact on your GPM can be substantial.

Looking ahead. This GM checklist is a great beginning to your Profit Mastery checkup. There’s one more key GM issue that must be addressed—sales volume—and we’ll look at that in a later article.

Meanwhile, do you have a great example of how you’ve used the road map to find hidden dollars in your company? Or a good shrinkage story? Send them to lefever@brs-seattle.com and I’ll feature them in an upcoming article.

Steve LeFever is founder and president of Business Resource Services (BRS) and a popular speaker at The JCK Shows. Working in partnership with JCK, he has developed customized presentations and workshops for the industry, all focused on helping jewelers make better financial decisions for their companies. His workshop, “Benchmark Yourself: The Power of Peer Comparatives,” will be held June 3 at The JCK Show ~ Las Vegas. For more details, visit the JCK Web site atwww.jckgroup.com. For more information on BRS, call (800) 488-3520 or visitwww.brs-seattle.com. Do you have an issue that’s related to the numbers side of your company? Send it in—we’ll be sharing our responses to the most-asked questions in future articles.