Outside of senior leadership, many employees do not spend much time talking or thinking about our “cost-to-serve” or “transaction costs” when it comes to generating sales. Depending on where you sit in the organization, your view of profitability (and success) may vary widely from other employees—and from reality.
Business leaders need to make sure that company sales representatives understand the true transaction costs or “cost-to-serve” when it comes to processing an order, so the company is adequately compensated for providing an “exceptional customer experience.”
So, let us look at those costs with a simple example of one salesperson who sold $6.5 million worth of products with a gross profit margin of $ 1.17 million at 18%. To achieve this, the company processed 8,000 invoices (32 per day) in support of its customers.
Below is a traditional view of this salesperson’s results for the year.
It is normal for us to look at our sales team’s performance and ask:
- How much did we sell?
- How much did it cost us?
- How much did we walk away with?
What neither the salesperson nor the sales manager knew was that it cost the company $200 to process each invoice. The CEO and chief financial officer knew but the information had not been shared. When you consider your transaction costs and allocate them on a per-invoice basis, it provides a truer measurement of profitability.
When we take 8,000 invoices and multiply them by $200, we find that it costs the branch $1.6 million to process the invoices. So, here is a truer picture of the numbers from above. Instead of making $1.17 million at 18% like they thought, the reality was they lost $430,000 and their percentage was a negative margin of 6.62% in what we refer to as extended gross margin and extended gross margin percent.
Can you see why it is so important for your organization to know your transaction costs or cost-to-serve? Do you see how this concept links to the conversations around pricing discipline, upselling and promoting services? In the above example, the sales professional and sales manager were thrilled by the $1.17 million in margin. However, they did not know their transaction costs. The leadership team looked at the same data and saw a loss of $430,000 and 24.62%. The reality was they actually paid their customers $430,000 for the privilege of buying from them.
And we are only looking at one salesperson here. Imagine the importance of this topic if your company has 10 or 15 or 20+ salespeople.
There are workable solutions for our salesperson and their “portfolio” of customers. One has to do with understanding why the salesperson generates the number of invoices that they are receiving. In many cases, 80% of their volume represents the majority of those 8,000 invoices (or 32 invoices per day), which led to the $430,000 lost margin.
One of the things we have discovered is that every salesperson’s base has a story. Meeting with our salesperson and manager and looking at their accounts will reveal which customers are creating the most invoices. It allows us to find answers to questions like:
- Are we delivering and processing four, five or more invoices a day?
- Are we consolidating orders when we can internally?
- Are we automatically shipping when available or can we ship when complete?
- Have we reached out to customers to understand what we can do to consolidate or reduce the number of deliveries or invoices with them?
The last bullet point is important because our customers also have transaction costs, so having a meaningful conversation with them, backed with real data, could create a win-win and create savings on both ends. Very few distributors have these types of business conversations with their customers. This is an excellent opportunity because their costs most likely mirror our own.
These discussions can help create an environment of “transparency, candor, honesty and trust” that may strengthen the relationship between us and our key customers and allow us to pick up more of their discretionary business.
Small improvements can have huge positive impacts
We asked ourselves what would happen if we had meaningful conversations with our salesperson’s key clients and were able to reduce the number of invoices by 10%.
In the graphic above, we wanted to see what the incremental savings to the branch would be if we went from 8,000 invoices down to 7,200 per day. Or, more simply stated, from 32 invoices per day down to 29.
If every invoice costs the branch $200 and we go from 32 invoices per day at $6,400 to 29 invoices per day at $5,800, we save $600 per day. And if we multiply $600 by 250 workdays, we have the potential to save $150,000. And that’s just from one salesperson!
If you have 10 salespeople and each reduces the number of invoices by 10%, there could be $1.5 million in incremental savings that drop right to the bottom line. I’m not suggesting everyone reduce their invoices by 10% but when it makes sense to do so, you can see the positive impact on earnings.
Experience has taught us that when the workforce becomes aware of the costs and challenges associated with running a business, it better understands why driving margin is vital. Motivated and knowledgeable employees working on driving financial results are a beautiful sight to see, especially when higher net income results.
So, in the end, we know it is a constant battle between improving operational efficiencies, driving financial results and sharing successes from a people, profits and customer perspective but if you can get the entire distributorship to see the business through the same lens…this is a very good thing.