This has always been a great question for retailers. Should we attack the bottom line by focusing on shrink, cost of goods or gross margin?
Obviously all retail companies would like to focus on all three areas and there are even sub sections of these top line areas that we could spell out as needing attention. The challenge is where to deploy already taxed resources?
It does not require an accountant to figure this out. If we assume that COGS or cost of goods and services is about 75% of top line revenue that would result in a simple gross margin of 25%. Based on a number of industry reports we are also safe using a shrink number of 3% of top line revenue.
This author is aware that there area a few companies with shrink below 1% and cost of goods below 75% which means there are also companies with gross margin better than 25%. The obvious question is; are these companies that solution providers want to target for profit improvement sales? Probably not.
So let’s look at an example of shrink improvement with data analysis tools and process improvement tools versus cost compression with SaaS e-procurement tools. Let’s assume we have a company that does top line sales of $1B. Using a shrink number of 3% shrink would be $30M annually. If you were able to reduce shrink by a third in one year, profit improvement would be $10M. If this were a supermarket company with a 1% bottom line or $10M, improvement could be as much as 100%.
Now let’s take a look at reduction in cost. If we assume the same company has COGS of 75% or $750M and that we were only going to address 20% of that number or $150 and only reduce those costs by 20% which is slightly above industry averages the net profit improvement would be $30M or 300% improvement in year over year net profit. If we were only able to achieve 10% savings which is well below industry averages, net profit would improve by 150%.
I’ll leave the gross margin example for you to figure out. In the above case it is clear that attacking COGS has an impact on the bottom line of up to 3 to 1 versus addressing shrink with your already taxed resources.
We look forward to and appreciate your comments.