The following position was offered relative to the title. “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?
During the post we answered the areas of shrink and cost of goods and services. The question now is how would we focus on gross margin and what would the bottom line impact be?
Let’s begin by restated our gross margin assumption. 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%. Now that we know our gross margin, it is pretty simple to measure the impact. The first step is to look at the categories which generally fall into gross margin reduction such as the expense category. Examples might include employee benefits, construction, insurance and not for resale purchases etc.
We already know that our gross margin dollars are equal to 25% of our fictional company’s sales of $1B or $250M. Therefore the impact to the bottom line at most could be a percentage of $250. The next logical step is to look for the largest category spends with in the gross margin area. Let’s assume that employee benefits are 15% of payroll costs and that payroll costs for our fictional company are 15% of revenue. For our $1B retailer payroll would be $150M and benefits would be 15% of that or $22.5M. If we attacked health benefits costs and were able to reduce them by 20% the improvement to the bottom line would be $4.5M or 45%. This would certainly be a worthy target, but would not impact net profit as much as our shrink or COGs models as discussed yesterday. To summarize the impact to net profit as discussed in both posts.
1. COGS up to 300%
2. Shrink up to 100%
3. Gross Margin up to 45%
Please remember these numbers are fictitious.
We look forward to and appreciate your comments.