Income Statement Provides Road Map to Higher Profits

I recently had a conversation with a vending operator who shared with me that all of his snack/pop routes were producing over $10,000 per week in sales. In fact, two were consistently producing more that $12,000 per week. Needless to say, I was impressed with his performance and began questioning him on how he was able to accomplish that feat. His simple response was, “I buy what sells.”

My natural instinct was to ask the question, “Won't that kill your rebate?” Being a former sales representative for a major vend product manufacturer and the chief financial officer of a regional vending operator, I knew that unless you align your purchases with the manufacturer's rebate programs, your rebate is reduced or eliminated.

The operator's response was that although he did not hit a rebate number, he virtually never “stales out” any product in his warehouse or machines. This includes fresh pastry!

The conversation made me rethink about how I look at a vending income statement. I asked myself, “Is it possible to drive the bottom line outside of reducing product cost through rebates?” The answer is, “Yes!”

This might be an obvious answer to some, but in recent years, many operators have become too focused on maximizing rebates. There are several reasons for this, the main one being that rebates are one of the simplest ways to increase profits.

Every veteran operator knows that running a vending business has become very challenging. With costs rising, operators naturally want to protect their profit margins. Passing price increases on to customers is tedious and the outcome is never certain. Finding new locations in today's market is equally difficult. And adding new services requires a lot of planning and upfront investment, and again, the outcome isn't guaranteed.

Cost of goods: a focus for many operators

As the CFO for a large regional company, I was no different than many other vending operators. I was constantly challenging our product procurement team to manage our costs of goods. It was not an easy task. There are many variables that go into producing cost of goods such as sales price, purchase price, stales, theft, miscounts on inventory, and rebates. It is a complex number that requires constant management.

We partially drove profitability by focusing our growth on particular manufacturers. Growth and the related rebates can enhance profitability, but it's tough to grow product lines by double digits year after year. The better payouts on rebate programs require you to do this.

In retrospect, some of these actions were short sighted.

The fundamental reason for making a financial business decision is to improve profitability. The answer must be, “Yes,” when the question is asked, “Will this change create more profit for my organization?”

The primary reason to drive revenue is make yourself more profitable and at bare minimum to keep pace with the constant increases of expenses.

When times are as challenging as they are today, the best approach is to review all aspects of the operation in search of maximizing profits.

The most important tool the operator has to understanding profitability is the income statement. The income statement summarizes sales, costs and profits.

Income statement: a useful tool

Based upon the NAMA 2007 Operating Ratio Report, the typical vending operator is actually producing a higher gross profit than the high profit operator. In fact, gross profit is actually 2.4 percent better for a typical operator than for a high profit operator.

Being a high profit operator is not the result of better cost of goods sold, but by reducing payroll and operating expenses as a percentage of sales.

The typical operator, according to NAMA, has a 49.6 percent combined payroll and other operating expenses. The high profit operator, by comparison, has a 43.7 percent combined payroll and other operating expense. That is almost a 6 percent differential. In an industry that produces a 2 percent to 3 percent bottom line, it is obvious what is driving profitability.

How is this occurring? In most businesses, there are fixed and variable costs. First, let's consider variable costs.

Variable and Fixed costs

Generally speaking, cost of goods sold is a variable cost. As we drive revenue, our cost of goods sold increases proportionally with our revenue. If cost of goods sold is 50 percent, then 50 cents out of every dollar of revenue is spent on buying product. Some will argue as revenues increase, rebates increase. And as a result, some reduction of cost of goods sold is realized.

My counter argument is that it is tough to hit growth rates every year. Even if you have a supplier who doesn't have growth requirements, they have facing requirements. Machine facing requirements can be detrimental to top line growth. With facing requirements, slower moving products are being merchandised in the place of faster moving products.

Another example of a variable cost is route driver salaries paid as a percentage commission of what their route produces.

Holding fixed costs constant, which exists as a portion of payroll and operating expenses, are areas where driving the top line can have an impact on profitability. Fixed costs in payroll include warehouse personnel, administrative staff, counters in money room, and other positions that are not tied directly to revenue.

Fixed costs in operating expenses include depreciation, maintenance, rent, utilities, property taxes, and other similar items. If an operator is able to keep those fixed costs constant as revenue increases, those fixed costs as a percentage of sales declines.

The difficulty lies in keeping the fixed costs constant as the business grows. Normally, as a business grows, there is a requirement to add additional help and facilities. Unfortunately, this drives up fixed costs.

Pricing: A major challenge that needs constant work

Getting the right pricing in your machines is important to driving top line sales. Realize that in most markets, the products that are offered in the vending machines are less costly than what a consumer pays at his local convenience store.

In my market, there is as much as a 40-cent differential in retail and vending prices for a 20-ounce beverage. Raising vending prices so they are closer to retail can help increase top line revenue. The key to closing the gap is to position the vending as being superior to that of a retail outlet. Here is where marketing comes into play.

Vending brings products to the customers and the customer can request the items that are offered as the selection. The vending operator needs to believe this before he can convey it to customers. Then he must communicate it to customers through his marketing and advertising. (This is a topic for another article.)

Pricing changes require planning

In order for a pricing strategy to be effective, there must be a plan developed and adhered to. At minimum, a yearly pricing plan needs to be developed and implemented.

There are even times, as in 2005, with the multiple increases in pastry, where a mid-year increase might be warranted. Once the plan has been established, it must be executed.

I have found that most customers, if you are servicing them properly, will allow you to increase the selling price of your product as your costs increase.

Customer presentations are important

A good presentation is important to help your customer understand the increases you have incurred. The key to a good presentation is to have your facts together.

Put together a packet for those people responsible for raising prices at the customers' facilities. The packet should show supplier price changes.

It is very effective to include a copy of the cost increase on a supplier's letterhead. If an increase is sought by a supplier, be sure to have them give it to you on their letterhead. Additional information in the presentation should show how the cost of operating the business has increased. Increases in fuel as well as the increase in insurance are two other points that may be presented to a customer.

Getting permission to raise the price is only the first step. End users will normally stop buying as much from the machine when prices increase, but this is only a temporary reaction. Providing the prices are not higher than what the consumers pay at most retail outlets, they will begin buying from the machines again as if nothing happened.

Product selection is critical

Seeking less expensive alternative products is another way to protect profit margins, but the chances to do this successfully are limited if we have been using the most popular products in our machines.

We have all seen situations when we have been presented a product line that is similar to the line that we are carrying but is offered at a discounted price. The discounted product doesn't have the brand name or the marketing, advertising and sales support behind it, but it presents us with a savings.

You purchase the product to see it sit in your warehouse until you force it out to the drivers. The product then sits in the machines until it is “staled out.” Have you really saved any money? Have you really driven down the cost of goods sold?

No. In fact, you have probably done just the opposite. The phrase “fast nickel, slow dime” comes to mind as a good rule of thumb when buying cheap, non-turning items. A “fast nickel” is produced when you are putting quality product in the machines that the customer wants to buy. As the spirals spin, you reduce stales and drive revenues.

A “slow dime” occurs when you have bought a marginal product at a cheap price. If and when the product does turn, you can reap a greater gross margin, but the downside is that you have filled your machines with products that limit revenue growth. Have you really driven sales?

In addition to reviewing the income statement, the operator should periodically review route structure.

Route planning must be reviewed

No discussion about profitability is complete without mentioning route organization. Payroll and vehicles are among the biggest expenses in a vending operation, and their management has a big impact on profitability. Routes must be organized as efficiently as possible, and they must be reviewed as account volumes change.

There are several incremental costs of operating a vending truck that is routed inefficiently. The price of fuel is currently the key driver, but other costs that increase with miles driven are oil changes, brakes and tires. These expenses can be considerable when viewed in the aggregate over all routes.

The purpose of a route plan is to consolidate a driver's activities into as small a geographic area as possible. By limiting the driver's area of service, more machines can be serviced in a shorter period of time. The result is greater revenue production utilizing the same assets.

This can be challenging for a growing company, especially when a route driver is doing a great job at an out-of-the-way location. Both the driver and the customer want the driver to stay at the location, but it might not make economic sense for the vending company.

Route changes require driver buy-in

Route planning, like many aspects of the vending business, needs to be reviewed at least annually. The first time a major route overhaul occurs can be difficult. However, after it has been successfully completed several times, those involved in running routes can see the benefit.

The mental “conversion” for the driver, who is normally the one most affected by the change, occurs when they: 1) see an increased paycheck for the same amount of time; or 2) see a paycheck of similar size to what they are used to with fewer working hours.

Consider one final point on route expenses. What if your route planning is so successful you can take a truck off the road? Think of the savings of oil, gas, brakes, and tires, and reduced insurance premiums.

Additionally, as the business grows, the extra truck can now be used to service the new accounts. As a result, expenses such as depreciation expense and interest expense, which are fixed in the short-term, become smaller as a percentage of sales. As fixed costs are reduced as a percentage of sales, profitability increases.

Income statement: a key management tool

One of the great benefits of operating a vending company is the simplicity of the income statement. For most, revenue is derived from three primary sources: vending, office coffee service and manual food operations. Expenses are generally categorized as cost of goods sold, personnel, and overhead.

Because of the financial structure's simplicity, focused attention in one area can have a positive impact on financial results.

The goal for the profit minded vending operator is to improve profitability by driving top line sales and managing the fixed costs of the organization.

About the Author
Paul Humphrey is a veteran financial officer for vending and OCS companies based in Tulsa, Okla.

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