Albert D. Bates, Profit Planning Group

An overlooked factor in the payroll cost challenge is the inability to control operating economics. Many distributors process too many orders, and many of those orders are of too little value.

A major profitability challenge facing distributors during the past decade has been the inability to lower payroll costs as a percent of sales.

This challenge has continued despite new technology focused specifically on payroll, such as automated order picking, online ordering and enhanced fleet scheduling.

There are several reasons for the inability to lower payroll costs. They range from escalating health care costs to a shift in the employee mix toward higher-compensated employees, especially in the information technology (IT) area.

One overlooked factor in the payroll cost challenge is the inability to control operating economics. Many distributors continue to process too many orders, and a large portion of those orders are of too little value. Distributors must face this challenge directly.

Let’s examine the nature of order economics from two perspectives: 

• The nature of order economics. An analysis of how even small improvements in the average order size can yield large profit gains. 

• Order size strategies and tactics. A discussion of the opportunities to improve the economics of a typical order. 

The Nature of Order Economics

The figure below examines the nature of operating economics for the typical PEI member based on the latest Distributor Profitability Report (DPR) published for PEI by the Profit Planning Group. As the report indicates, the typical firm generates $10 million in revenue and processes 2,500 orders a year. The orders vary in size, but the average order value is $4,000. This is with an average of four lines per order. Each line has an individual value of $1,000.

The results indicate that the typical firm is extremely productive in its warehouse, trucking and office operations. That this large workload can be handled profitably is a credit to PEI members.

Firms, however, potentially could become more profitable if they could maintain high productivity while generating additional sales volume. The key involves focusing on the number of lines per order and the average order value. The result should be higher sales without additional activity or cost.

When most firms think about enhancing sales, they look to increase the customer base. Although desirable, this does nothing to change the economic structure of a typical order.

With more customers, firms can increase the number of orders averaging the same number of lines per order and the same order line value. Sales and payroll costs tend to move upward together.

In contrast, if firms change the nature of the orders received from existing customers, they could enhance sales with only a modest increase in payroll costs. The assumption is that the same set of customers would place the same number of orders, but with some minor tweaks to order sizes. (See the Potential Results column in the figure below.)

At the top, the number of orders remains the same. The first change is that the number of lines per order increases from 4 to 4.1, a modest change. The net result, though, is that the number of order lines processed increases by 250. This represents slightly more work, however, because the number of orders being processed is the same, but the increase is modest.

From a strategic perspective, the 250 more lines processed means that competitors collectively are processing 250 fewer lines. It is an operational and competitive change.

Finally, the average line value is increased by 1 percent, which takes the figure from $1,000 to $1,010. Again, it is a small but probably challenging change to the firm’s operations.

The net result is that sales increase from $10 million to more than $10.35 million, an increase of 3.5 percent. It is not an earth-shattering number, but it is important. It represents organic sales growth that is independent of the market. It also is achieved with only a modest increase in payroll costs.

Order Size Strategies, Tactics

The two keys to changing order economics significantly require developing a sophisticated information reporting system and a more action-oriented mindset. The proper information must be available, and it must be used in decision-making.

Information reporting system. If a firm does not know its average lines per order or average line value, then it has no chance of improving them. It is not enough to have the information at the total firm level. The information must be accumulated and available for reviewing individual customers and individual salespeople — inside and outside sales. This is another example of big data in management. Existing technology means having such information available is no longer a major challenge.

Action-oriented mindset. Collecting the information is an essential first step, and it’s not particularly difficult. Developing improvement programs based on that information is much more challenging and time-intensive. It necessitates specific approaches to improve the two order economics pressure points identified in the figure. 

• Lines per order. Superficially,this would seem to be nothing more than a “would you like fries with that” effort. This is where information on salesperson performance comes in to play. Overtime sales people get tired, develop bad habits and fall into low-performance ruts. Continual follow-up and reinforcement is required. 

However, there is also a strategic component at the total firm level. Understanding the range of products that customers would like to purchase is essential. Items not in the product line can’t add to the lines per order. It also is necessary to have the items in stock on a systematic basis. Being out of stock causes the lines per order to fall to zero. 

• Average line value. This is the more challenging of the two improvements in the figure. It also is more profitable. 

Customers habitually order only the quantity they need now. Getting them to buy more is a battle. By explaining to customers that placing a lot of small orders costs them more money, it is possible to help them plan and buy more less often.

More impactful is to raise prices where there the opportunity exists. This cannot be an across-the-board activity. In every business, there is the potential for modest price increases on slower-selling items. Eventually these small changes add up.

Moving Forward

Technology is important in helping control payroll costs. Technology alone never will produce meaningful changes, though. The key to controlling costs is to consistently review order economics.

Albert D. Bates, Ph.D., is founder and president of Profit Planning Group. He is the author of the newly released “Breaking Down the Profit Barriers in Distribution” available through Amazon and Barnes & Noble.