Welcome to the Real Profit Drivers, which is the latest in the AED webinar series. My name is Al Bates, and I'm delighted to be with you today to talk about profitability. It's based upon the cost of doing business survey, which AED provides to its membership, and our company has the honor of conducting that particular survey, so I know a little bit about what's going on from a financial perspective, not an expert in the industry per se, but know a fair amount about finance, and we're going to talk about how do companies make more money, what I like to call the Real Profit Drivers, what causes us to be more profitable or less profitable in our particular business. Now it's a webinar, and I've got some rules here. Number one, you're supposed to have your phone on mute, which I assume you do, which means please feel free to scream and yell at other people in the room, particularly the yell, I told you so, if I say something that you've been trying to get across to your other friends in the business, and they've not been able to understand how brilliant you were. So scream and yell, I think that's really starting, I love that if you do. The two real big rules are, number one, you cannot see me, so you're going to have to follow along when I tell you to turn to an exhibit, you have to turn to an exhibit, you really got to stay with me, and when I tell you to write, you have to write, because what we're going to do is we're going to talk about some issues and some concepts and some ideas, and you need to stay with me, and there are places, not many, but there are some places where you absolutely have to write some things down to make sure you're with me. Well with that preamble out of the way, let's talk about what we're going to do. You should have a handout that we'll send out to you ahead of time, and if you go inside the handout, exhibit number one, the exhibits are numbered there for you, and so exhibit number one, objectives of the session. Okay, what are we going to do? I'd like to do three things. I want to review the profit structure of the industry, that is I want to talk about some of the things that were in the cost of doing business survey that I thought were particularly interesting. Now you can read as well as I can, so I'm not going to duplicate, you know, ad nauseum things that you saw, but there were some things that I thought were kind of interesting and maybe a little bit unique and different about this industry that we ought to address. And then number two, I want to look at what I call the key pressure points in improving profitability, and what it turns out is in every line of trade in distribution or in dealerships, there are two things that drive profitability. And I need you to appreciate those as well as I appreciate those, and hopefully I can impart my understanding, and you can accept or reject my ideas as you go, but I really want to focus on what should we worry about. What are the factors that really cause companies to be more profitable or less profitable? Then towards the very end, I'm going to try to put together a little action plan to say if I were you, here are the things I would worry about. I obviously cannot make a plan for your business, that's pretentious on my part. But I would like to suggest there may be some things that you really need to have in your plan, in your programs going forward, and I'd like you to understand those if you could. So that's what we're going to do. Let's start with the profit structure of the industry, and on exhibit number two, I've got the typical firm in our particular survey. And this survey, again, was designed to look at what's going on in the industry. And we had 99 companies take part, which is a nice, big, juicy sample out there in the world, and it's doing $50 million. So it's a large company, most people in this industry are reasonably good size, which means you've got a legitimate business, and you sell some things, you also rent some things it turns out, but all that revenue screen has a cost associated with it, the cost of the product, if you will. And if I subtract the cost of goods, the cost of the product from sales volume, I get gross margin, and it's about 21%. Do me a favor, please, this is what I told you you're going to have to write. Next to gross margin, just write two words, if you would. Those words are too low, okay? And the gross margin needs to be a little bit higher, and I've got a real reason why I think it needs to be higher, which I'll get to about another dozen exhibits back or so. Just got to get the gross margin a little bit higher than it is, okay? And I've got a question already which has been typed in, which says what you're supposed to do if you have a question, should you have your CODB back, and I believe you should by now. So if you've not, I will make sure you get that back in the mail immediately. So we've got a gross margin of 21%, it's too low. Got to do better than that going forward. Then down below that, we take the expenses of the business, and we divide them into two categories, payroll and fringe benefits, and everything else. And payroll and fringe benefits is everybody's W-2, everybody's social costs, Medicare, Social Security, everybody's workers' compensation, everybody's 401K program, and everybody's health insurance. That is, it is a fully loaded, fully burdened number. And if you look there, the all other expenses down below payroll are the expenses that are not payroll. Rent, utilities, depreciation, interest, bad debts, all those sorts of activities that we have. And if you look at the numbers, payroll and fringes as an entity, okay, and it's a lot of people, I'm aware of that, but payroll and fringes as an entity is about 60% of our expenses, okay? We are a people business, okay? We provide services. And if you provide services, guess what? People have to provide those services. Most people, as it turns out, like to get paid, which I think is reasonable and fair for them to do so. So we had a little bit of a challenge that we got a lot of payroll, but it's all justified because we're providing the services. However, having said that, I'd like you next to payroll and fringes, if you would, just write two more words. And these words are important. Those words are too high. Now, that's a cheap shot on my part until I explain it. I do not think we should lower the payroll and fringes, okay? We need to have people get paid fairly, but what I want to make sure is that it's ideally in relationship to the sales and the gross margin that we generate, okay? So what we are got in that particular situation is we've got all the payroll associated with the business, and we are trying to say, can we make sure that we maximize that particular activity out there in the world, okay? So that's where we are. Now, we are going to now look at the very bottom line in the analysis, and you've got to jot this down because I think it's left blank intentionally. Payroll after expenses subtracted from gross margin gives me profit before taxes, three and a half percent. So what we've got is we have got a bottom line profit of three and a half percent, which is not bad, okay? Not bad at all out there. It's a decent sort of number, but it's not as good as it ought to be. And if we could improve the margin, and if we could improve the payroll and fringe benefits a little bit in our particular business, we could, in fact, I think, be a little bit more successful going forward in where we'd like to be. So that's exactly where we are. And now, there was a question about where service labor is. That's a cost of goods sole factor, as has been identified. But we're looking down below at the payroll that is of the people who are doing administrative selling, that sort of activity. So the cost of goods is a fully loaded, all the activities associated with the product and the services that we sell, and the payroll expenses is the people who are supporting that activity, okay? Now, Exhibit 3 says, let's look at the recent trend in profit margin. And we've been doing this survey since the dark ages. And what we have is we have got profit margin over time. And if you go back to the last five years, it's been in that three to four percent range. And I would like to argue that we're in a rut. It's not a bad rut. I mean, a rut sounds like, boy, it's really terrible. It's not terrible at all. But it is a comfortable rut. But it's still a rut, particularly if we compare it to where the most successful dealers are in the industry. So I'm not bothered by the fact that we are in this rut. But we've got to break out of the rut. We really ought to do a little bit better if we could going forward. And so I'm going to argue that we're doing pretty good. I can't complain about three and a half percent. But I can say some people do a heck of a lot better. And what we'd like to do is identify how do they do a lot better, what's involved in that process. Now, before I go forward, I'm going to give you a little bonus exhibit. It's not in your handout. It should be on your screen. And what I would like to suggest is we should try to, if we could, get to somewhere around an eight percent bottom line. Now, the reason I say that is we do the survey. And the most successful companies in the industry are somewhere around seven, seven and a half percent. And I think we could stretch it to eight if we really worked at it. So I'm setting a goal, not arbitrary, not at all. That's a goal based upon what the most successful firms in the industry do. And I'd like to see if we could get to about eight percent. Notice if you will, though, on my bonus exhibit, I think it's going to take us a little while to do it. I think we're going to have to slowly, systematically crank out improved performance in our particular business. I don't think we're going to do it overnight. So I've kind of got a thought process. And that thought process is slow but steady wins the race, kind of a tortoise and hare view of life. I think we could do a heck of a lot better. We're going to go from somewhere around about three and a half percent to about eight percent. We are, in fact, doing a heck of a lot better. But I think it's going to take us a while to get there. And I think we need to have a little bit of patience in terms of doing it. And the question is, okay, I'm going to have some patience, but what should I have patience about, what should I do in my particular business, what's involved in that process? Before we can do that, I've got to look at one more exhibit, which is in your materials. It's exhibit four, and it's the recent trend in sales growth. And this particular exhibit gives me a little bit of chest pains. What it says is our industry, by the very nature of the fact that we have a lot of big ticket stuff, and if it's a big ticket stuff, we tend to be a little bit boom or bust. The problem that we have, to me, from a financial perspective, is boom and bust makes it very difficult to put in place all the concepts and ideas we'd like to do. Because in the great years, look at 2011, my God, we had sales growth in 2011, about 22 percent or so, went to 15, they went to under five, then it went back up, then it went back down. What we tend to do is we tend to add expense in the good years, and we have to try to figure out is there a way to take the expense back away in the bad years. And so episodic sales growth, which is what we've had, boom or bust sales growth, if you'd like to use that particular phraseology, is really tough to put a plan together, to put a concept together to build a business. And I'm going to argue on exhibit four, because I've just put two lines up there, and the lines are somewhat not drawn quite correctly where they ought to be, there ought to be a line at about five percent. So if you do me a favor, if you're following along and going with the flow, put your line over about five percent. And five percent, to me, is the minimum sales growth that we need to have. And we have, over the last five years, we've missed it twice. I also am going to argue, and now you will come to the phone and try to beat me up, that somewhere in the 10, 12 percent range is about as much as we can digest successfully. It doesn't mean for a moment that if I got the opportunity to grow 20 percent, I don't grow 20 percent. Of course you do. Nobody has ever turned down sales volume that I know of. But what it does say is, from a financial perspective, looking at not just your industry, but looking at a lot of other industries and distribution that we track, once sales volume gets real strong, it strains the business both financially and operationally. And so what we'd like to do is make sure we stay in that range. So you're not going to buy off on a maximum number, but let's buy off on a minimum number. We've got to get sales up 5 percent every year, which is difficult to do in a boom or bust industry. But I'll have a couple of things to talk about that towards the end of the program, how we're going to make sure that we achieve that goal. It's one of the real overwhelming goals that we have in our particular business. Great. So we've got a goal. I'd like to get to somewhere around an 8 percent bottom line, which I think is reasonable based upon the survey that we have. And I'm going to do that by trying to get my sales going at least 5 percent, and in my view of the world, not try to have a hyper-growth rate, although I'm going to let you do it. What I want to do on the next four exhibits is share with you some data that was developed in a very large survey of distribution of which AED took part. We're going to go beyond just AED, and we're going to talk about distribution or dealerships in general. And what I want to do is address what seems to drive profitability in all of distribution. I'm looking for universal rules, if you will. I'm looking for the holy grail of profitability. And I don't know for sure that I found it, but I think I found it, and what I'd like to do is make sure that we are there in that particular regard. So what we have on exhibit number, and it says 17 for some reason, but I think it's actually exhibit number 5 in your handout there. What we have on exhibit number 5 in your handout and on the screen is what I call the do three things well model. I want to look at, if we could, six things that drive profitability. Number one, up there at the very top, how large are you? Sale size. Number two, sales growth. How fast are you growing? Number three, your gross margin versus your peers. Number four, what are your operating expenses versus your peers? Your DSO, day sales outstanding, how fast do you collect? And then your inventory turnover. And what I want to begin to do is look at, if I could, what is the impact on profitability? Now this is a complicated chart, so I want to make sure you follow me. This chart is based upon a survey that we did of 885 distributors across 17 lines of trade, including AED. And what we tried to do is say, are there rules that apply everywhere? And we think there are. And the first rule is, how do various factors cause us to be more or less profitable? Now the way you read this, because I got to make sure you follow along. The way you read this is, if there is a checkmark, for example, go to the very top line, there's a checkmark for gross margin, a checkmark for expenses, and a checkmark for DSO. The way you read this is, if I do better than half of the people in my industry, okay, and there's 99 people took part in this survey, so if I do better than 50 people in the industry, what does it do to my PBT? And so every time there's a checkmark, I am in the 50th percentile. So this is a classic high-low test. What that means is, versus your peers, not versus any other industry, don't worry about other industries, but versus my peers in the same industry, what causes me to be successful? Now if there's a checkmark, that means you're at least in the top half. And you could be the 98th percentile. You could be the 51st percentile. We're not doing that. That's a little bit complicated for the analysis. We're just asking ourselves, am I better than half the people in my industry? And we just arbitrarily chose, could you do three things better? Okay, three things better out there. I could have chosen two, I could have chosen four, but three seemed nice. So what we have done is we've taken all the combinations of doing three things better, and we have listed them in terms of how impactful they are on profitability. So the top one, gross margin expenses in DSO, if you go over a little bit towards the right, it causes my PBT to be 147 percent higher than the average. Or in our industry, it would cause the PBT to be about 8.7 percent. Wow. And they go down the line. So the further you go down from 1 to 20, the less impactful this combination is. Now some people, incidentally, okay, might in fact not do anything better than the average. That's possible. And some people might do everything better than the average. That's all. But we simply took three things at a time in terms of performance. And here's where life gets, to me, extremely interesting. Notice it says the top four and the top six. If you go to those top four factors on this particular chart, all four of the top four say we're better than average on gross margin and simultaneously we're better than average on operating expenses. And then the other check marks are just random. There's a very important moral here, a very important rule here, and it is only life and death. So please hang with me. Those companies that are most profitable appear to be those that can simultaneously, and this is what's tough, simultaneously be better than their peers, half the peers, on gross margin and expenses at the same time. Now between you, me, and the wall, it's extremely easy to be better than my peers on gross margin. It's extremely easy to be better than my peers on expenses. It is unbelievably difficult to be better than my peers on gross margin and expenses at the same time. And that's what really is life and death about this particular exhibit, and we're trying to focus on what is the thing that caused me to be successful. And I look at those, and man, gross margin expenses jump out, and expenses actually jumps out a little bit more than gross margin because the top six all have to do with controlling expenses in my particular business. Now this is bizarre, absolutely bizarre. I would also notice if you go all the way to the bottom, okay, and for those companies who did all six things better, okay, they actually had a slightly lower PBT impact than those that just did the top three better. Now I'm not saying, don't worry about everything, I'm not saying that, but I am saying that those companies that could focus on the big two, focusing on everything didn't really seem to help a heck of a lot. And so I need to have you committed to, to the extent that you can, I need to have you committed to saying, we need to identify, if we can, the ways in which we are going to combine gross margin expenses. And we're not going to be the star on either one of those, but we're going to be in the upper 50% on both at the same time. Now let me drop the other shoe if I could. If you look at the right-hand side exhibit, I have put the words, what's wrong with this picture up there. We have at the last column the number of firms that are doing this. And if you notice at the top, the number of firms that are doing the top four that really drive profitability, there ain't many of them. If I come down the line, I get some nice big numbers. And what it says is, very few firms are able to combine gross margin and expenses at the same time. And that's simply because it's hard to do, as we'll talk about in a couple of seconds. But what I got is, I got only a few companies are able to achieve this level of performance that I need to have. And I need you to be out there focusing on gross margin and expenses. I'm going to relate this specifically to your industry in a couple of seconds. And I know for right now, this is a big survey, lots of industries, and you're going to say, well, maybe it doesn't apply to us. I'm going to prove, hopefully, that it does apply to you in a couple of seconds. But for right now, hang with me. It applies to you. It is actually what you need to do in your particular business. But I want to graph this. I've got 20 different strategies. The ones at the top really drive profitability. The ones at the bottom, OK, if I do the bottom three, it barely drives profitability at all. And so what I would like to do, if I could, is look at the relationship between the number of companies, the right-hand column, and the impact on profitability, and I want to graph that. And so what I have on exhibit number six is I've got 20 dots. And what these 20 dots say is the more I move out to the right on this graph, the more this combination impacts profitability. So I simply took those dots up there at the top, and the number one improves my profitability PDT by 147.5%, and I've got a dot out there at 147.5. And so I've got the big four over here. I've got the big four over here. And then on the vertical axis, how many firms are doing it? And here's what, again, is just absolutely bizarre. The things that drive profitability, not very many firms do them. And I've labeled this so profitable yet so unloved. That's a little bit strong that I'm going to talk about in a couple of seconds. But it turns out that not very many companies are able to put together a program that allows them to control the gross margin versus expenses, those four dots over there, and be successful. Now as you go to exhibit number seven, I'm going to give you a little quiz. And that little quiz is why don't we focus on the big two? Why don't more companies combine gross margin and expenses simultaneously? Why don't they do that? And there's two possible answers. Number one, which I put on the screen, we're stupid, which I would say is not there. The big one is the next one. It is blooming hard to do. It is incredibly difficult to do this. As I said a couple of seconds, it is not that difficult to be in the top half on margin. It's not that difficult to be in the top half on expenses. It is incredibly difficult to be in the top 50% of both of those at the same time. So I'm asking you to do something that is not that easy to do. And I would like to demonstrate if I could, since you should be on exhibit seven, why it's difficult. And exhibit seven is labeled gross margin and expenses join at the hip. I now have on your screen and in your handout 885 dots, 17 lines of trade. You are some of those dots. What we're doing is we're looking at the interaction between gross margin and expenses. And I've got a regression line, which I've drawn through there. And I want to make sure we're clear, because sometimes this graph confuses people. If you go to the very bottom, there's the word gross margin hanging out down there. That gross margin is going from left to right. It's not up and down. It's left to right. And what it says is if I am towards the left on this particular graph, my gross margin is low versus other people in my industry, okay? Even though there's lots of industries, we're not comparing across industries. Every dot is how do I do versus other people in my industry. If I'm towards the right, I'm good on gross margin. And then the vertical axis is expenses. If I'm at the top, I've got high expenses versus my peers. If I'm at the bottom, I've got low expenses versus my peers. And that's good. So the quadrant we want to hang out in is the lower right-hand quadrant. The goal is can I get down in that lower right-hand quadrant? And the answer is not many folks get there. The problem we have in every industry, don't feel like you are the only industry, is that sometimes we do things that help us drive a higher gross margin via our product mix, via our whatever we do, the types of customers we are servicing, the extent to which we have high cost services. A lot of things drive our margin up. But as those things drive our margin up, they also tend to drive our expenses up. And that's why I'm labeling this joined at the hip. You need to break that linkage to be successful. What I want you to be in, and I just put this down here on the chart, is I want you to be in the top 50-50. I want you in the 50-50 club. That's a club I've started. And the 50-50 club is one I want you to be in. I want you to be in the top 50% in your industry with regard to gross margin and expenses. You can be 51st percentile. That's good enough. And you can be 85th. That's even better. But I'd like you to be in that 50-50 club. I'd like you to join that particular society if you could, because it makes my business profitable. And I've got a question that just popped up. Are we going to use the AED survey to benchmark and know if we're 50%? The answer is yes. You're about one exhibit ahead of me there, so hang in a couple of seconds. I'm going to show you how we know that. Before I do, though, however, I'm going to suggest an even tougher club. I'd like you to be in the 40-40 club. This one's brutal. This one is really brutal. And maybe I'm hallucinating here. But the 40-40 club would mean I am better than 60% of my peers on margin and expenses at the same time. Notice as I get down there, there ain't many dots left out there. Even if I throw the guys in a line, they barely make it. It's a tough club. It's a really tough club to be in. So let's go for 50-50, and if we could get 40-40, that would be absolutely thrilling. So the opportunity and the challenge that I have in life is can I begin to move in that particular direction to be more successful and be more profitable, and the answer is I got to get in that 50-50 club. Exhibit number eight says, well, what happens if we do it? And if I'm in the 50-50 club, that top line, my PBT is going to be about 118% higher than the average bear. My ROA, return on assets, is going to be about 83%, and if I'm in the 40-40 club, the numbers just go off the wall. I mean, my PBT is 226% higher, just obscene. Also very, very difficult to do. So I'm going to settle for the 50-50 club. And I had a question that popped up, how am I going to know I'm there? And the answer is, I'm going to tell you after we write one thing down. I need you to go to exhibit 23. I said when I tell you to turn, turn. Let's go to exhibit number 23, and let's write this down, if we could. And when you get to exhibit number 23, I'm such a wonderful human being, I've already written this one for you. The key profitability issue in all of distribution, including the wonderful folks in AED, is the interaction of gross margin and expenses. Can I do some things that cause my margin to go up without my expenses going up right along with it, or can I do some things that would cause my expenses to go down without it killing my gross margin? That interaction, I honestly believe, is the key to life. And I've been looking for the key to life for like 30 years in distribution, and now that I'm too old to enjoy it, I think I've actually found it out there. It is that interaction, and that is empirical evidence. That's not me making it up. That's not me winging it, or me saying, hey, I think you ought to do this. That's empirical evidence. Great. You go back to exhibit number 9, which is where we're going to be in a couple of seconds. And before we go to exhibit number 9, though, I'm going to address the question that's been put out is, how do I know I'm there? How do I know I'm in the 50-50 club? And the answer is, you take part in the AED cost of doing business report. And if you do, you get back a long document. I mean, the document gets back, I can't remember, like 30 pages long. It's got thousands of numbers in it which are all over the place. But the real key thing to me is you get this page, okay? It's what we call a scorecard. And what the scorecard does, it says, how do you compare versus your peers? This is exactly what we're talking about. And I've got four categories at the top if you see those. Inspect, fair, good, and strong, okay? Inspect means, eh, it ain't all that good. Fair, good, and strong. If you go to the line between fair and good, guess what? 50% line. All these are 50 percenters in this particular business. And so you get instantaneous feedback every year. Am I in the 50-50 club on the factors that count? Now you also get information, are you in the 50-50 club, on a lot of stuff. But the ones that really matter are the interaction between gross margin and expenses. So we're not leaving you out in the lurch. We're actually telling you where you are based upon the survey results that you have. And again, based versus your peers. So you get this automatically. You get it in print form. You also get something else that's new this year which you may or may not have looked at. So I want to make sure you're aware of it. It is on your screen. And again, it's a bonus exhibit. You don't have these. They're just to show what you get. We have something called turning benchmarking into action, okay? And this is a little, just like everybody likes to have, a little dashboard, if you will. But this dashboard is different. This dashboard says, if you look at the top and if you can read these, how am I doing with regard to some factors out there in the industry? What's my return assets? What's my profit margin? What's my gross margin? What's my expenses? And what we're trying to do is say, how do we look versus our peers? But also, what can we do about it? So what we have, if you come down and join me about line number three, the gross margin is the 46th percentile. Hope you see that. And the operating expenses is the 68th percentile. Okay. Same old problem. Good on expenses, bad on gross margin. Hard to get them both to do together. And like all dashboards, it's got some little color-coded things. Should I check it? Is it green, red, or blue? But here's what's important. Here's what is absolutely important. It allows you down at the bottom to make some changes in key factors in your business. And as you make changes in these key factors in the business, it will automatically update what percentile are you on gross margin, expenses, asset turnover, ROA, et cetera. It'll give you real-time feedback. And so you can begin to say, golly, if I made some changes, big or little changes, would it drive me to be a better performer in the AED world? You got that this year, I believe, free of charge. That's our lowest possible price. So you got that. And I'd like you to take a look at that, if you would. It's in the package of materials that you got. Only if you took part in the survey. If you didn't take part in the survey, congratulations, you don't get this. You can still buy the overall survey if you didn't take part, but you cannot get the individual analysis. It's only to those people that provided data. With that said, back to the narrative. And a question at this point in time is, well, is AED different, or is AED like the other industries? Are you conning me here? And exhibits number 9, 10, and 11, and 12 are all designed to say, how do we look? So what we're taking is the typical company, and we're asking ourself is, what would we look like in terms of our PBT? So we're taking PBT on the vertical axis, and it's struck there at about 3.5%. And we're asking ourself, what would happen if we made some changes? All these exhibits, 9, 10, 11, and 12 are, what happens if we make some changes? And so exhibit number 9, what if we change inventory and accounts receivable? And the way you read this is, if we did 5% better, 10% better, 15, 20, 25, going out on the horizontal axis, what if we did better? And that doing better would mean, what if we could reduce the inventory or the accounts receivable by 5, 10, 15, 20, 25% without causing my sales to go down? And the answer is, gee, that looks like a couple of pretty flat lines. Those don't seem to impact the bottom line in a major way. And this, again, this is AED specific. So what we're saying is, what we said earlier, these are not drivers of performance. Well, what is the driver? Exhibit number 10, if we could increase our sales. Ah, yes. Now, we're looking at this to make sure we're clear. If we could do better than we actually did. So what we're saying is, we had a sales number for the year, and I believe for my typical AED number that we used a couple of seconds ago, that number is $50 million. And what this is, is what would have happened to our bottom line if we had done 5%, 10%, 15%, 25% better than the $50 million? So if you go out to the 10% line, that would mean, gee, what would we have looked like if we had done $50 million plus 10% is $5 million, if we had done 55. And using some analysis of the results and formulas, I'd be at somewhere around, looks like maybe 4.5% PBT. So sales volume, sales growth versus what we actually did is a driver performance. Of course, it's a driver performance. However, it's not one of the big two. The big two are on exhibit number 11 and exhibit number 12. And exhibit number 11 says, what would our bottom line look like if we had been able to lower the expenses? Now, I want you to look at the screen, if you would, please. And this is not exactly PowerPoint. I'm going to try it. There's exhibit 10. There's exhibit 11. Hopefully, these are toggling right along with you, 10 and 11. And what it says is the following. A 10% reduction in expenses has a heck of a lot bigger impact on your bottom line than does 10% more sales. That's terrible. I hate that. But I got to live with results. It is what it is. I hate it because most people despise expense control. Expense control is almost always thought of as going backwards. No, expense control is putting profit on your bottom line. And we may hate expense control. We may hate the entire thought of expense control. But it puts a heck of a lot more profit on your bottom line. And that's what we need to do is have a better bottom line. Expense control is a driver. So we are no different than what we found in this gigantic survey that we did across industries. The last exhibit, exhibit number 12, and I've got to move because they're going to get the hook out, is gross margin is a slightly more impactful driver in our industry than is expenses. And so if I toggle those two up there, they're both the big two. The gross margin for us is a little bit bigger driver of profitability than is expenses. So we're not immune to life. We're just like everybody else in the world. We're not immune to the factors that drive profitability. We've got to begin to say, can we get control of the things that improve profitability in our business? With that said, I want to turn now specifically to some of the results of the cost of doing business survey for the last about 20 minutes that we have left in our discussion. I want to look at about four or five exhibits from that report that kind of struck me as interesting, starting on exhibit number 13. And exhibit 13 is simply what do the typical folks look like? What do the high profit folks look like? And the typical number was 59 million. I used 50 million in my little case study I built earlier. It's a rounder number than 59, 648, 850. But the first thing that pops out is sales doesn't seem to be a gigantic driver at the aggregate level at least. What is a driver is the next one down is the high profit folks grew a little bit faster. They were in that sweet spot. If you remember, my sweet spot is at least 5%. And you thought I was just bloviating there. Not the typical firm, about 4.3% growth. The high profit, 9% growth. They got in that 5 to 10 to 12% sweet spot. They did a better job. Next line down, gross margin. Unbelievable to me. Gigantic difference in terms of gross margin as we're going forward. Wow. Almost 3.5 points difference. That is night and day. Now there are different ways of doing business. Different ways of doing business. So it's not all gold. But if I come down and look at the next two lines, payroll and total operating expenses, the high profit folks better on margin and almost parity on expenses. So I'm kind of in that 50-50 club. Not quite in that 50-50 club. But pretty darn close to it in terms of profitability. But again, these are median numbers. These are aggregate sort of numbers. So individual companies would be in the 50-50 club. But overall, they're not. And then finally, PBT. 3.7. I think I used 3.5 for my little sample company because it was nice and round. 3.7 versus 7.3. Gigantic difference in terms of performance. Huge difference in terms of performance. And I'm particularly struck by the margin difference. And so I'm looking for what are the things that cause my margin to be different. Are there things out there? But before we get to that, let's go back to Exhibit 23 again, which is my summing conclusion. And you've got to write this down. This time you have to write it. It's not there. So go to 23 and let's write. And I will write it along with you because I can talk faster than you can write. Gross margin is especially important for AED members. So our distinction between distribution and dealerships as a whole is gross margin seems to play a little bit more important role than it does in some other industries that we might look at. Gross margin is really important. And so that leads me to the next question, which is what the heck drives gross margin? How do I know what drives gross margin? And that takes me back. If you have written on Exhibit 23, and I'm assuming you got that written down, let's go back to Exhibit 14. And this says one of the things that impacts gross margin is the sales mix, that the typical and high profit have got a little bit of a different mix in terms of what they provide to customers, that the high profit folks are a little bit less in the rent to sell mode and a lot more in the rent to rent mode. And that has, I believe, the capacity to drive my gross margin up because of the nature of the margins on those factors. I'm almost identical with everybody else with regard to parts, and I'm pretty close to typical and service, a little bit less service out there, which I found a little bit surprising. But the whole difference seems to be in terms of sales mix on the front end products that we provide. So one of the factors that drives gross margin is the way we go to market in terms of the mix of products. The other way, which to me I think is even more important, is we get paid for what we do, and that's Exhibit 15. Now, Exhibit 15, you need to label this because I did an absolutely terrible job of labeling this. These are gross margin percentages. Every one of these is a gross margin percentage, and nowhere does it say that on the stupid exhibit. That's my problem. But we're looking at the gross margin percentage, typical versus high profit. And on machine sales and rent to sale, a little bit higher gross margin. Parts, a little bit higher gross margin. Service, a lot higher gross margin. And so to me, the sales mix issue is important, no doubt about that. But to me, it's a fundamental issue of, can I get paid for what I do? And those people that have the higher margins and tend to be a little bit more successful figure out a way to get paid for what they do. It's a reality of life, if you will. It's a pricing discipline issue. It's a lot of issues, but it's one that needs to be addressed directly because it's not that they're all in easy product categories or they're all in easy territories. They get a little bit better margin across the line. Particularly, I like the service differential, about six points on service. And I still find 59 a little low. I'd like it to be 60 or so, but they do a better job. All right, a couple other things that popped out. Exhibit number 16, product focus. And we kind of have two industries almost here. We have people who are focused largely on 100 horsepower or less. And those people who are focused largely on 100 horsepower or more, they're not mutually exclusive. You can do both. But generally, there is a product focus. And the result is that the people on the smaller horsepower equipment are smaller firms. They have better sales growth, and they got better margin. I do not know if that is God telling us something or not. I have no idea out there. But they also have higher operating expenses. They're different models, if you will. There are different ways of doing business out there in the world. And the PBT is pretty close to similar. I don't get real excited when I got a difference of four-tenths of a point. It's enough to catch my attention. But they're pretty much different businesses with different ways of getting to the bottom line, but about the same bottom line when you get there. So different approaches, different methods, same bottom line result out there in the world. One of the things that really pops up to me, though, and this is unique to this industry, and that's asking the question, does size matter? And it's on exhibit number 17. And I have got a set of results here, which I have no ability whatsoever to tell you why it's happening, none whatsoever. So what we got in the top half are the people selling equipment under 100 horsepower. And they're broken to three volume categories. Let's make them small, medium, and large, under 25, 25 to 50, or 50. And if you notice, the gross margin tend to be a little higher for the small people. The expenses tend to be a little bit better for the medium folks. And the medium folks have a dramatically bigger bottom line. Wow. If I go down to the bottom, which are the over 100 horsepower, I've still got three categories, but the categories are different. They're still small, medium, and large. But since these people are generically larger, the small is under 50, then 50, 100, over 150. Same sort of situation. Margins are a little bit more tended towards the middle. And the middle guy has the highest bottom line. I'm going to tell you, I threw up my hands because I have no idea why this occurs. You'll have to figure it out. In every line of trade where we do analysis, usually the middle size firms are the least profitable. And all of a sudden, I come into this industry, and the middle size firms are the most profitable. Folks, I cannot explain it. It is unheard of in distribution, so you have stumped the band. I'll let you worry about what the implication of that is. I just flat do not know out there. But the results are the results. That those people who are kind of mid-range have not just better, but I would argue demonstrably better performance than those people who are either small or large. One more finding out of the results, and I'm going to give you some guidelines for success, I hope. And that's Exhibit 18, which looks at seasonality. And we break the world out of the short seasons, modern seasons, and long seasons. Basically, how often can you drill something into the ground here? And it turns out that long season does tend to have an advantage. There's no doubt about that in the world. They tend to have better sales growth. Their margins are tight, but they do a heck of a lot better job on the expense side. And their bottom line is 4-2 versus 3-8 and 3-7 going back to the left. So they do better in a long season. Nothing that I don't think is all that surprising. It's a little bit better economically to be operating in a business that I've got year-round sales potential than if I have some real challenges in terms of winter. All right. Again, they're going to break the hook out, so I'm going to go real quickly through two exhibits and then go to my giant conclusion. My two exhibits I'm going to look real closely at is the fact that historically in distribution on exhibit number 19, we've tended to have a pricing structure that's oriented towards the bigger the customer is, the lower gross margin we make on them. This is a classic exhibit number 19. It's the way we've always done life. And there's nothing inherently wrong with it because big companies are theoretically more economical to service. I can afford to give them a lower gross margin. And so it's not a giant problem. But a lot of research has been done recently to suggest that some of those big companies that buy a lot actually aren't very profitable. And some of those small companies that don't buy much maybe are profitable. And there's been a real push to replace exhibit 19 with exhibit number 20, which says what we need to do is we need to begin to say, what is my cost to service customers? This gets a little bit more complicated. This requires you to be a little bit more sophisticated in your thinking, but come back and say is, are those customers that are expensive to service, they tie up my sales force? They have lots of emergencies. They have lots of things that cause my expenses to be high. Are we charging them more as we should? This is difficult to do because it requires an expense analysis to be able to figure out life, but it's what I think I need to do. All right. I've got to put one more conclusion. Then I've got one more conclusion on exhibit number 23. Then I've got a long last two exhibits. So exhibit number 23, I'm just going to rephrase this the way I've got it on the chart. We need to rethink. We need to rethink. Several key parts of the business. I've got to think about how am I tying gross margin expenses together? Do I have the right product mix in my particular business? Am I charging the right gross margin in those various parts of the business? Am I relating my pricing structure to the economics of servicing different customers? Am I doing all that at the same time? That's a real challenge to do. It requires me to begin to rethink what I'm doing. I have now got two exhibits left. They're fairly long, so I need to make sure we follow them. Exhibit number 21 says an improvement model, a rack suit plan. I'm going to develop a generic plan for an AED distributor. There is no such thing as a generic AED distributor. We're all different, slightly. We're all similar overall, but we're all unique and different. So what I'm developing is what I like to call a rack suit. A rack suit means that there are four bullet points on this list. You need to have each one of those bullet points in your plan. It's like you have to have a coat, and you have to have a pair of pants, and you have to have the pants cuffed, and you have to have a zipper, and you've got to have all that. These are generic concepts. However, you've got to cater them. I'm going to put some actual numbers in here. Those actual numbers are for a generic company only. You've got to change it for your particular business. So I'm going to give you a rack suit. You must, must, must, must have these four points in your plan going forward, but the numbers are different. Starting number one, increase sales by at least the inflation rate plus a safety factor of 3%. This one actually is not so much rack suit. This one's kind of to me driving a stake in the ground that we all need to address. A lot of our expenses tend to grow each year right along with inflation. We need to find a way to continually outpace inflation, and my outpacing rate is 3%, and this goes back a long time ago to that chart in which I said there was a sweet spot on sales, and that sweet spot on sales is right now at least 5%. I came to that because the inflation rate appears to be around 2% right now. Nobody's sure, but we think it's 2%. If I add 3%, I get 5% sales growth in today's economy, but it's not just 5%. It's the inflation rate plus 3%. That is something every firm needs to be as a bullet point in your plan. So it's not a rack suit right now. It is an important one-size-fits-all part of this rack suit. The next one is different. Now here's where you've got to begin to identify some things and think about them and develop them for your business. I want to force my payroll to grow slower than sales. Every employee wants a raise. I guarantee you. I don't even have to ask them. Everyone I want to raise, of course they do, and they probably deserve a raise. You have good employees. They deserve more, but if I just every year do what we've historically done, which is sales and payroll kind of go up together, which is what they've done incidentally in AED for about the last 20 years, I don't make any more money. I don't improve performance. We're getting more sales, but payroll goes up right along with sales. So I need to have what I'm going to call a wedge or a delta or a difference or whatever term you want to use. I'm going to use wedge so that payroll grows 2% less than sales. That's a small change. It's crucial. Now for those of you who really have control of payroll, maybe the number is 1%. For those of you who do not have control of payroll, maybe the number is 3%, but it probably is somewhere around 2%. So this says, and make sure you follow this please, if sales grows by 5%, 5 minus 2% wedge is payroll can only grow by 3%. I need to begin to say, let's change the business. You may be sitting there saying, that's incredibly easy, I'll do that, no problem. And my answer is, we have not done it in AED in about the last 20 years. And my feeling is, if we ain't done it in the last 20 years, I think it's kind of hard to do. If we look at payroll expense as a percent of sales in this industry, it's currently running somewhere in the general vicinity, depending upon how you look at the world, it's looking somewhere in the 10.5% range, which is what I said in my little opening exhibit, exhibit number one. If I go back to 2011, it was 10.5%. If I go back 20 years ago, it's 10.5%. Assuming we're not in an inflationary year, or we're not in a recessionary year, a normal year, we have not driven a wedge. I want you to drive a wedge. I'll get off my soapbox, I apologize. Increase the gross margin percentage, not the dollars, by about a half percent. And this is simply because there is such a large difference between the typical and the high profit firms with regard to gross margin. And again, this is one you have to tailor. Maybe it's 3 tenths, maybe it's 1 tenth, maybe it's 6 tenths, I don't know. But you need to have a gross margin improvement plan as part of your planning process. You need the bullet point. The number you put on that bullet point is up to you. And then finally, I need to decrease the other expenses by somewhere around 1 tenth, wow, that's really knocking them dead, okay, 1 tenth of a percent. That will tend to happen kind of automatically if we keep the sales going north. Now, nothing happens automatically as you well know. But if I keep the sales going north, these expenses will tend to go down as a percent of sales. They'll go up in dollars, but they'll go down as a percent of sales. The problem we have in the industry is because of the nature of the product, sales don't keep going north. What if my typical firm did this? What if my typical little company that we had in exhibit number one did these four things? That takes me to exhibit number two, 22, which is my final exhibit, and I can do it in three minutes and we'll be done right on time. Sales growth of 5 percent a year. 50 million goes to 52, and obviously I got 2015 as my base year, and we're already halfway through 2016. But assuming we started in the 2015 number, 50 million, 5 percent a year, in five years I'm at 63 million. Gross margin, 21 to 21.5, ends up at 23 and a half percent. That's really nifty. That's knocking them dead. But I believe we said earlier that the high profit folks are already at 24. So I'm not really doing anything that's obscenely difficult to do. I am simply suggesting let's close the gap from typical to high profit systematically over time. And the gross margin dollars go from 10 to 5 to 14 million. Payroll and fringes. Payroll is going to grow by 3 percent because sales are growing by 5 percent, and I need to have a 2 percent delta. And so 5 million, 250 at payroll, growing by 3 percent, gets to 5 million, 407, and ends up over the life in five years at 6 million. Now in a couple seconds we're going to say it may be going up in dollars, but it's going down as percent of revenue. Other expenses going to go down. Finally, my bottom line. Wow. 1,750,000, not bad. Goes to 4,700,000. Are you kidding me? No, I'm not kidding you. Gigantic difference. Gigantic difference. The bottom of the exhibit shows percent of sales. And what I want to indicate is two things. Going down to the bottom part to the payroll and fringes. Payroll and fringes going down as percent of sales. Something we have not been able to do in 20 years. But going back up to the dollars, going up in dollars, down as percent of revenue. Nonpayroll expenses going up in dollars, down as percent of revenue. And finally, if I do all this, my bottom line profit, 3.5 goes to 4.3, goes to 7.5 percent. It's a nice number. It's a nice juicy number. I wanted to get you to 8, but I didn't. But again, it's a rack suit. You've got to tailor that rack suit to your own needs. I'm going to do two things real quickly, one of which you need to understand. First, I'm going to go to exhibit 23 and write down a self-evident concept. We probably should have a plan. Of course, everybody has a plan. I know that. I'm not belittling you here. But what I am suggesting is everybody should have a plan that encompasses those four bullet points that I identified. Sales growth, payroll wedge, gross margin, and other expenses. You need to have a plan that puts those two things together. All righty. One final thing, and then I will shut up. On the cover of your handout, which you got, there is an email address. A lot of people do not want to ask questions during the session because it's financial and you're a little bit concerned. If you go back to the cover, I believe the bottom line is the date. Next above that is my website. And then my email address. If you have a question you would like me to answer privately, get that question to me by 5 o'clock today, Boulder, Colorado time. That's the mountain time zone where nobody lives. So 5 o'clock Mountain, 7 Eastern, 4 Pacific. I will answer it tomorrow privately and confidentially. I will get you an answer to address what your question is. With that, I enjoyed being with you. Thank you very much.

webinar

Al Bates

profitability

distribution industry

gross margin

expenses

sales growth

2% wedge

payroll

tailored plan