Albert D. Bates, Profit Planning GroupDuring the past few years, the emphasis in distribution has moved from improving operations to completely rethinking the nature of the business. New ideas have included dramatically reducing the number of customers served, using big data to gain a marketing advantage, structuring separate Web-based entities and using mobile technology to preempt competitors. Countless other strategic initiatives could be listed, too.Lost in the discussion is managing the existing business for greater profit. It is not that distributors lack desire to improve profitability, but the idea of improved performance from blocking and tackling better seems so 20th century.Examine the economic realities of improved operations from two perspectives:The economic impact of small improvements. How modest operational changes can lead to much higher profits.Guidelines for operational improvements. Opportunities for blocking and tackling better.The Economic Impact of Small ImprovementsFigure 1 examines income statement performance of a typical PEI member based on the latest DPR Report. As indicated in the “current results” column, the typical firm generates $8 million in revenue. It operates on a gross margin of 26.3 percent of sales with expenses of 23.3 percent of sales. As a result, it generates a pre-tax profit of $240,000, or 3 percent.Figure 1: Impact of 1 Percent Improvements for Typical PEI MemberIncome Statement ($)Current ResultsPotential ResultsPercent ChangeNet Sales8,000,0008,080,0001.0Cost of Goods Sold5,900,0005,937,7900.6Gross Margin2,100,0002,142,2102.0Payroll Expenses1,100,0001,089,000-1.0All Other Expenses760,000752,400-1.0Total Expenses1,860,0001,841,400-1.0 Profit Before Taxes240,000300,81025.3    Income Statement (%)   Net Sales100.0100.0 Cost of Goods Sold73.873.5 Gross Margin26.326.5 Payroll Expenses13.813.5 All Other Expenses9.59.3 Total Expenses23.322.8 Profit Before Taxes3.03.7 The “potential results” column reflects the impact of three modest, seemingly inconsequential improvements. The specific improvements are: 1) a 1 percent increase in sales; 2) a 1 percent improvement in the gross margin percentage from 26.3 percent to 26.5 percent (26.3 percent times 1.01); and 3) a 1 percent reduction in total expenses. It is blocking and tackling better personified.Although each improvement in operations is a modest 1 percent, the impact on profitability is far from modest. The firm’s pretax profit increases from 3 percent of revenue to 3.7 percent. More consequential, the dollar profit increases by $60,810 — a 25.3 percent improvement. This increase in profit provides a basis for financing the foray into more strategic actions.For years, I’ve repeated the mantra, “Little things mean a lot.” Admittedly, many distributors have tired of hearing the refrain. As a result, the idea of systematic improvements has lost favor. The profit impact of such improvements suggests it might be time for an operational renaissance.Guidelines for Operational ImprovementsIt is one thing to talk about operating the existing business more effectively. It is something else to actually do it. In essence, how does the firm block and tackle better? In making the improvements there are two important issues to consider—(1) focusing on what matters and (2) developing a consensus in the business as to what those item really are.Operational focus. Three areas of change drive the financial improvements in Figure 1: net sales, gross margin and expenses. Each must be addressed. In doing so, firms must avoid overcomplicating the improvement actions required. Emphasize focusing on a few key issues.Net sales. Research in distribution routinely indicates that many distributors are missing anywhere from 3 to 5 percent of their sales potential for one basic reason: They cut their inventory investment. The move in distribution to cut back on inventory began nearly a decade ago as firms began to take more financial views of their businesses. Inventory reduction continues despite research that shows the two main customer complaints about distributors are inadequate service and assortments that are too narrow.Gross margin. For most firms, a significant and largely untapped opportunity exists to improve the gross margin percentage. It involves identifying items where prices can be increased without affecting the firm’s competitive position. Such items, nearly all of which are slow-selling SKUs, represent a small proportion of sales volume. Yet they have the potential to contribute to a significant improvement in a firm’s overall gross margin percentage. Every pricing study has found a potential gross margin improvement that is at least three times as large as the improvement in Figure 1.Expenses. Most distribution managers are tired of hearing about expense control. The Great Recession and another eight years of tepid growth left most managers feeling that there is nothing left to cut. They might be right. The key to expense control is not to cut expenses or to become more productive. Expense control must emphasize internal order economics, a topic covered in previous articles. The battle is to get the maximum number of items on every order. If that can be done, expenses will fall systematically as a percent of sales, even as they continue to increase in dollars.Operational consensus. As distribution businesess increase in size and scope, they become more bureaucratic. Too often they move beyond bureaucratic to being balkanized. Recent research on lines of trade by the Distribution Performance Project unveiled a lack of consensus among managers regarding what’s important in improving performance. Half of managers think their firms should slash prices to gain sales volume. Meanwhile, the other half want to increase prices.It’s not just the sales folks who push to lower prices. Uncertainty about what to do afflicts every aspect of an operation. With such disparity of understanding, little chance remains to make improvements.Achieving goal congruence depends on management education. There is often a feeling that “they all know that” about the impacts of inventory reductions and other issues. But in reality, half of management doesn’t know.Education must provide a basic understanding of what drives a firm’s profit. Your goal isn’t to make everybody an accountant. But you must ensure all managers understand the economics of price cutting, for example.NextDistribution is amid significant change. Each firm must look for new strategic initiatives, new technology and new ways to service customers. If firms ignore the profit opportunities in the existing business, they severely limit their ability to participate in the new distribution future. The existing business is a massive profit improvement opportunity that must be optimized.Emphasize blocking and tackling better.Albert D. Bates, Ph.D., is the founder and director research 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.