Losses from big customer avoided
Audioline was a £25m turnover business importing their own range of telephones from China and selling them direct into all the major UK retailers.
One of those retailers was B&Q.
With annual sales of £1m, B&Q was comfortably Audioline’s biggest customer.
Those high sales combined with a ‘higher than average’ gross profit margin of 33% meant that B&Q was also Audioline’s most profitable customer too.
BUT.
That all changed when one day B&Q demanded a bigger volume rebate.
What’s 3%?
During the discussion about the following year’s product range, B&Q announced that they would be taking an extra 3% volume rebate.
The existing agreement meant B&Q were entitled to a volume rebate of 5% on all sales – now B&Q wanted 8%. On the face of it an increase of just 3% when you’re making 33% gross profit didn’t seem that much.
But…. on sales of £1,000,000, it meant £30,000 would be added onto the costs of the business. That in turn would lead to £30,000 coming off the bottom-line profit.
The sales report clearly showed in black and white that B&Q were the biggest and most profitable customer. HOWEVER…….
Was this ACTUALLY the case?
Could the business REALLY AFFORD to incur the extra cost?
The sales team said ‘yes’.
The finance team was unsure – after all biggest doesn’t always mean best.
Only a detailed Customer Profitability Analysis of the B&Q account would provide the answer.
Biggest isn’t always best
The reason why everyone else was ‘unsure’ was that B&Q were known to be a very demanding and ‘high maintenance’ customer.
That high level of service meant additional costs throughout the business were being incurred. Uptil now it was a widely held belief that those additional costs were largely insignificant compared to the high sales and ‘above average’ gross profit margins.
To get a true picture of the profitability of B&Q the Customer Profitability Analysis had to include every single cost directly associated with doing business with B&Q.
It included the cost of the products that were sold to B&Q.
It also included all the direct costs.
A direct cost was one which was only incurred because of something else – in this case, B&Q.
For the Customer Profitability Analysis to be accurate a thorough review of the business was needed. All the direct costs were, firstly, identified and then, secondly, the annual cost of them quantified.
It soon became clear that there were a lot of direct costs associated with B&Q. Some were obvious but others were fairly well ‘hidden’. It soon became clear that the total of the direct costs were actually a lot higher than what everyone thought…
Customer Profitability – Shocking Truth
Some of the direct costs that were identified and included in the Customer Profitability Analysis included the following:-
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- Annual volume rebate: B&Q took a 5% (soon to be 8%) rebate automatically every month from every sale made.
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- Sales return collection: B&Q raised a credit note the moment a customer returned product back to store. B&Q demanded that every customer return was collected within 30 days and if this didn’t happen then B&Q disposed of it. To avoid this Audioline was forced to pay thousands to a company to visit every B&Q store every month to pick up returned product.
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- Warehouse costs & penalties: Whenever a line item on any sales order could not be fulfilled then B&Q would immediately raise a penalty (worth thousands). To avoid these severe penalties a third of all the stock in the warehouse was ring-fenced just for B&Q. The stock and warehousing costs were considerable.
- Sales returns: More than 10% of all products sold to B&Q were returned by customers back to Audioline. The cost of this was colossal if it was all sent to landfill or back to China for repair. To minimise the damage, it was instead sent to a rework company who refurbished what it could. The refurbishment costs for B&Q returns of £40,000 was high but better than the £100,000 cost which would have been incurred by the next best option.
When all the direct costs were added up (remember these are costs which only exist because of B&Q) the total came to £300,000.
The shocking reality was that on the £1,000,000 sales made to B&Q the ACTUAL gross profit was a pitiful £30,000.
It was nowhere near the £330,000 which the sales report said the gross profit was.
By only including the cost of the products sold and excluding the direct costs the sales report gave a very misleading picture of the situation.
THE RESULT: At a stroke, B&Q went from being Audioline’s BEST customer….to being the WORST.
The uncomfortable truth was that B&Q was actually a loss-making customer.
That’s what had happened when all the indirect costs (those are the day-to-day business running costs such as rent, office staff, etc) had been added up and a portion allocated to each customer.
With so little gross profit being made from B&Q then any indirect cost allocation would have quickly turned a pitiful profit into a sizeable loss.
The Customer Profitability Analysis showed that Audioline just could not afford an extra 3% volume rebate.
That extra 3% rebate would have increased cost by £30,000 AND reduced both gross profit and bottom-line profit by £30,000.
It would also have reduced the gross profit made on the £1,000,000 sales made to B&Q to NIL.
With little prospect of significantly reducing the direct costs associated with B&Q it that meant that the most profitable way forward was to terminate the agreement with B&Q.
Within a few months that’s what happened – Audioline pulled out of B&Q.
Lessons Learned
It’s important to have accurate numbers.
It’s even more important to have clarity and a real understanding of what those numbers mean.
Without either the numbers or the understanding it is so easy to make a wrong decision.
A wrong decision could be worth a huge amount of money in terms of lost profit and cash to a business.
And in this case the wrong decision would have been to agree to the extra 3% volume rebate and just continue. If that had happened, then the losses made from B&Q would have continued to mount and ultimately pull the profitability of the whole company down.
