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Do thin margins really matter?

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One day I was handed three plastic promotional cards for food businesses at my local railway station. I wonder how many of these businesses are making money. I wonder what the ‘average spend’ is? I wonder if they've worked out a 'minimum spend' that will enable them to stay in business? $50 per customer? $30 per customer? Think about it. Thin margins. 


The anecdotal rule of thumb is that the cost percentage of a restaurant is about 92%, meaning that you might make 8c in the dollar if you don’t waste food in preparation, no one returns meals and the food and staff are fantastic. That's why the chefs on TV shows are so 'focused', 'bossy', driven', 'passionate' = 'stressed'. 

Because it’s a private business, only Maggie and her accountant have known the numbers… until now. An investor has announced that it was buying 48% of Maggie Beer’s food product business for $15m. That values the business at $31.25m. Sounds great.

But Net Profit Before Tax dropped 50% to $580,000 in the last financial year, giving it a profit ratio of 27% Before Tax (EBIT Margin).  Is that good? Let’s look at the numbers we have to work out from that article.

                                                           

The first point to take out from this table is that you should never take information on face value: you have to know what the metrics are and know how to calculate the ones you are not told.

The second point is that there is usually a reason why you are not told certain figures, or are not told the same figure each time. You need to work out that reason.

The third point is that people use terms differently. The report used ‘EBIT’ in one year and ‘Profit before tax’ in another … they may be different. Always ask; always check.

The article gave me some figures, but you want to compare a number of years (I like at least four). I worked out ‘rule of thumb’ figures for the 2014 year assuming a tax rate of 30% and that shows how much the performance of 2015 has dropped. Nineteen percent (19%) profit after tax is not much for a complex business such as gourmet food manufacture and sales - it is a thin margin. The question is whether it will drop again and whether there is a trend happening. What do you do about this?

So, well done Maggie in getting someone to invest in the business when the metrics are dropping. This allows her to ‘get some money out of the business’ (apparently $5m) or saves her putting in more to invest and carry all the risk ($10m).

What’s in this for us? Many of us will be facing exactly the same challenge of thin or ‘squeezed’ margins in our businesses, so what action do you take?


TWO ISSUES TO CONSIDER FOR YOUR BUSINESS OR PROJECT

You need to understand the context of the business and know the metrics that show what’s happening

A lot of ‘thought leaders’ now argue against the ‘if you can’t measure it you can’t manage it’ adage. But you need to know whether you are making the right decisions and whether your business or product is trouble. If you don’t give your executive the right metrics or answers they’ll start to doubt your ability.

What action would you want to see Maggie take? The new investor said “This is about the potential of the performance at the revenue level. Our focus here is to realise the potential of the brand… to create products and leverage the brand.”

Private equity people are usually ‘bottom line’ (profit)-focused so that’s why they want to see more revenue (increase either the price or quantity sold, or both] but often they just cut costs. On the same page of the AFR, the new CEO of Surfstitch said it had pursued ‘an unhealthy pursuit of topline growth’ before its share price plummeted.  It now seems Target has done the same thing over the last four years. Focusing on the revenue means that business-killing practices can be simmering.

Maintaining the price and GP margin are key to any business. If revenue is under pressure you’ll be told to ‘offer two for one’ and discounts etc etc but resist – look at the retailers who do that, especially those who do it all the time. It’s a sign of poor decisions and is bad for your brand. It’s time to think … of other sales channels, of new markets, of focusing on the points of different in the market, of improving the quality …of using social media...

The other way to increase profit is to cut costs. Maggie’s quality is known and trusted - beware, customers notice short cuts in a quality brand.

Manage your product portfolio (margin) mix

You will have some products that have a ‘good’ GPM and some may have a ‘thin’ margin. Where are products on their own lifecycle and the portfolio life cycle?

I recall Nobby Clark – one of Australia’s corporate leaders in the 1990’s – stating that managing a business is “all about managing the 3Ms: margins, mixes and masses.” I think about that often. I once had to state in an executive meeting:  “Revenue is price times quantity. Our price is right. We have a quantity problem because the courses have been reviewed as poor. We have to improve the quality and the revenue will recover. It will take at least two years to rebuild our reputation.” The trouble is that finance people want a recovery next month. 

You might have one product that has a thin margin. It might be your signature but high-cost product, or it may be one that is important in your mix, perhaps to thwart competition. A thin margin can be a sign that investment (a ‘refresh’ in marketing terms) is needed. As long as you are managing a strategy, a mix of products and some with a reasonable GPM (over 40%?) to support the products with a thin margin, might be viable. Remember that Abercrombie & Fitch left Australia because its GPM dropped to 65%! If your whole business has a thin margin, you need to rethink and examine every aspect of the business. 

TWO QUESTIONS TO ASK

1.   Do you know what is happening in your market?

There are many changes occurring; some dramatic. Do you know what your competitors are doing and what their product portfolio metrics are? Some companies are looking good but their metrics aren’t.

2.  Are you ready to argue your case?

When your executives are needing more income to meet results expectations - or just their budgets - you need to state your margin management strategy clearly and show you know what you are doing. They may not like what they hear, but such is life…


But WAIT there’s more…

I’ve been buying Maggie’s products for gifts, trying to help her grow her revenue. But the new investor was quick to move – preparing an Initial Public Offering (IPO) – for some parts of Maggie’s business. There are interesting metrics in the prospectus [Primary Opinion Ltd Prospectus]. Read them as you enjoy some fig paste...



For those in NFPs, Bridgespan (www.bridgespan.com) as US consultancy continues to update its research on diversity of income and margins. This is the hot topic at the moment - see  Funding: Patterns and Guideposts in the Nonprofit Sector.

For education purposes only 



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