5 - Margins and profitability

Question 1

What is the basic concept of margin?

Answer 1

To measure the profit of the business.

Question 2

Why is it important to ask how margins are calculated?

Answer 2

There is room for judgment in what can be included in a margin calculation.

Question 3

What is the gross margin?

Answer 3

A measure of the distributor’s value added, calculated as the difference between the price paid to suppliers and the price obtained from customers.

Question 4

What is the formula for calculating gross margin percentage?

Answer 4

$1,008m/$19,316m × 100 = 5.22 percent.

Question 5

What should neither sales nor cost of sales include?

Answer 5

VAT or sales taxes.

Question 6

What does cost of sales include?

Answer 6

• Inbound shipping costs
• Work done on the product (testing, processing, etc.)
• A fair allocation of labour and overhead costs.

Question 7

What reduces cost of sales and increases gross margins?

Answer 7

Discounts, rebates, or other price reductions received from suppliers.

Question 8

How does the cost of writing down inventories affect margins?

Answer 8

It reduces margins as soon as the loss is recognized.

Question 9

Are selling costs included in cost of sales?

Answer 9

No, costs of selling the product or sales commissions are not included.

Question 10

What is the difference between gross margin and mark-up?

Answer 10

Gross margin is gross profit expressed as a percentage of sales, while mark-up is expressed as a percentage of cost of sales.

Question 11

Why can gross margins be misleading?

Answer 11

They convey no sense of the size of business done.

Question 12

What is the potential risk of focusing solely on gross margins expressed as a percentage?

Answer 12

It may lead to lower overall gross profits and operating losses.

Question 13

What is margin mix or blended margin?

Answer 13

The management of product margins to optimize overall profitability.

Question 14

What can a distributor do to improve its blended margin?

Answer 14

• Reduce sales of low-margin products
• Increase sales of higher-margin products
• Add a higher margin product
• Increase sales prices.

Question 15

What is portfolio pricing?

Answer 15

Smart differential pricing within and across categories to achieve targeted blended margin.

Question 16

What impact does a small discount have on net margin?

Answer 16

A small reduction in sales can wipe out the net margin.

Question 17

What is a ‘low ball’ in pricing strategy?

Answer 17

The lowest gross margin at which the sales team can make a sale.

Question 18

How can regular analysis of margin performance benefit distributors?

Answer 18

It helps track the situation and take control of margin management.

Question 19

What is contribution margin?

Answer 19

A measure that reveals the impact of additional factors on profitability, such as pre-sales support and customer management.

Question 20

True or False: Gross margin and contribution margin are the same.

Answer 20

False.

Question 21

Fill in the blank: The gross margin is expressed as a percentage of _______.

Answer 21

sales.

Question 22

What happens when a distributor drops top brands to focus on higher margins?

Answer 22

It damages gross profits and market credibility.

Question 23

What does increasing the sales prices of certain products help achieve?

Answer 23

A higher blended margin.

Question 24

What is a potential consequence of aggressive discounting by salespeople?

Answer 24

It can lead to significant reductions in overall profitability.

Question 25

What type of opportunities can be uncovered by analyzing high-margin sales?

Answer 25

Niche opportunities worth developing into bigger business activity.

Question 26

What do the sales volume and margin distribution charts illustrate?

Answer 26

The relationship between sales volume and gross margin across different customer segments.

Question 27

What is the contribution margin?

Answer 27

The contribution margin deducts variable costs and cost of sales to reflect profitability more accurately. ## Footnote It helps to understand how different customer behaviors impact profitability.

Question 28

Why is contribution margin not easily comparable between distributors?

Answer 28

There is no definitive list of items that make up variable costs, and each distributor decides which costs to include. ## Footnote Distributors may create multiple contribution margins for different analyses.

Question 29

What do smart distributors do with contribution analyses?

Answer 29

They run frequent analyses by product category, supplier, and customer to identify performance differences and opportunities for improvement. ## Footnote Top performers can earn contributions 20% higher than average.

Question 30

What action did a distributor take regarding its biggest customer?

Answer 30

The distributor terminated the relationship with its biggest customer due to negative contribution margins caused by high service costs. ## Footnote This led to improved profitability and cash flow.

Question 31

What are the classifications of differential costs of serving customers?

Answer 31

* Marketing-driven costs * Sales-driven costs * Transaction-driven costs * Logistics-driven costs * Inventory-driven costs * Finance-driven costs ## Footnote These categories help in analyzing customer profitability.

Question 32

What is a key factor in analyzing customer profitability?

Answer 32

Mapping the cost to serve profile of a customer or customer segment. ## Footnote This graphical representation helps in identifying high-cost customers.

Question 33

What should distributors be cautious about when conducting analyses?

Answer 33

Distributors should avoid overly complex activity-based costing systems unless they can measure cost drivers and their variability. ## Footnote Complexity can lead to confusion rather than clarity.

Question 34

What defines fixed costs in a distributor's cost structure?

Answer 34

Fixed costs do not vary directly with unit volume and are related to infrastructure. ## Footnote Examples include warehousing and IT systems.

Question 35

What are two key measures used by distributors to track effectiveness?

Answer 35

* Average order size * Average cost of processing an order ## Footnote Small increases in order size or decreases in processing costs can significantly impact profits.

Question 36

What is the best measure of a distributor's overall profitability?

Answer 36

Net margin, as it represents profit as a percentage of sales. ## Footnote Different types of net margins can be calculated depending on the profit lines used.

Question 37

What is the significance of operating margin for internal management?

Answer 37

Management focuses on operating margin as it ignores interest costs, which may not be their responsibility. ## Footnote This focus allows them to concentrate on operational performance.

Question 38

What does break-even mean for a distributor?

Answer 38

It means the business generates just enough gross margin to cover fixed costs, resulting in neither profit nor loss. ## Footnote Operating near break-even is risky as small changes can lead to losses.

Question 39

What do investors in a distributor focus on?

Answer 39

They focus on net margin after tax as it reflects distributable profits post-tax. ## Footnote Investors expect management to minimize tax costs as part of their fiduciary duty.

Question 40

What challenge do distributors face in fast-growing industries?

Answer 40

They struggle to ensure that sales growth translates into improved gross margins amidst declining average sales prices. ## Footnote This can be particularly difficult in technology sectors.