June 27, 2017


Many recognize E=MC2 as Einstein's formula. Fewer know what the letters stand for - energy, mass and the speed of light squared, or, that it summarizes his theory of relativity. And, some theoretical physicists can explain the total story behind the equation and how it is a linchpin for understanding cosmic behaviors. Are there simple, but profound profit power equations for distribution companies?


The 11 super companies out of a universe of public companies that author Jim Collins unveiled in his book Good to Great1 all used simple, unusual and powerful measurement(s) that were guides for their continuous, innovative success. Two of the 11, Wells Fargo Bank and Walgreen Drug, used formulas that also relate to the fundamental profit power sources within distribution companies. Wells Fargo obsesses about growing gross margin and profit per employee (GM$/employee or "value-added/employee"), and Walgreen's aims to be the most convenient drug store with high profit per customer visit.

What are the deeper stories behind these ratios? Walgreen managers could probably tell us about many cycles of theories, experiments and successful discoveries that they have performed over the years in pursuit of improving profit/customer/visit for each sub-segment of customer (M 5.7-8)2. While competitors have imitated store layouts and pursued superficial, volume-is-vanity numbers like sales per square foot, Walgreen has been focusing on a customer-value, profits-are-sanity number that grew earnings and sales like crazy. Walgreen's stock price beat the general averages by 734% over a 15-year period, no other drug store chain came close.

Wells Fargo management has believed that great people deliver great service that delivers great customer retention and penetration that ultimately drives great profit growth. Great people require higher wages up-front, but then they have to work together to grow GM$/employee to even higher levels to support both premium wages and profits. When a profit center team gets measured and paid together to "run it like it is your own" the slackers don't last and prospective employees on file are waiting for spots. It works! Wells Fargo's stock price beat the averages by 399% over a 15-year period.

Can the GM$/employee and profit/customer ratios be successfully adapted and adopted by distributors as North Stars for a path to sustainable high performance. Yes, but .can managers get all employees to sign up for being part of the educated solution for executing the initiatives that lie beneath these two, inter-dependent, capstone numbers?


The GM$/person ratio is close to being an inverse measure for the "personnel productivity ratio" (PPR) which is "total people costs divided by total gross margin dollars" for a fiscal year. If this ratio increases, then less dollars are left for other expenses and profits. The PPR for most distributors has been trending upward for 10 years according to an important new publication entitled, Improving Distributor Profitability3.

In spite of spending more of the margin dollars on people, the persistent #1 problem in surveys of distributors over the past decade has been "finding, keeping and motivating good people." This problem and PPR management are linked by the flawed assumption held by 90%+ of all distributors that you can fight rising PPR creep for better profitability by hiring them cheap and working them hard.

2002's economic conditions will further stress PPR creep. People costs will continue to rise due to increases in health benefits and the pressure to match corporate America's merit wage increases. Margin dollars, however, will not rise as fast, because of slow to no growth in most channels and zero pricing power, if not deflation in the prices for manufactured goods.

Without manufacturers' price increases to pad a bit more and pass along, most distributors will not be able to grow margin dollars as fast as operational costs and will continue to struggle for profitability. Instead of freezing and then cutting wages across the board for all employees, now would be a good time for distributors to figure out how to strategically grow margin dollars faster than people costs. Then, their PPR would drop, the GM$/person and profits would rise, and the people problems would fade away.

Here is a logical progression of productivity plays for growing GM$/employee:

1. Get rid of personnel cross-subsidies. If best employees are being paid close to the same as least effective employees, then downsize, upgrade, re-orient and revitalize. Let the bottom X% of the payroll go and give up to 100% of the salary savings to the remaining people as an incentive to see if they can do without replacements. The dismissed won't be missed, and the stage will be set for signing all employees to a commitment to grow GM$/employee to much higher levels in order to support even higher wages for each job category. As an extra precaution, recruit some new prospective people at the higher wage rate to see what type of quality is available. Having excellent candidates on file is another way to keep veteran survivors from slacking off.
2. Explain the new vision. By executing the productivity plays below, the average distribution center can double their GM$/employee by working smarter, not harder. The high value-added per employee ratio is the key to supporting both higher wages and profits to reinvest into future growth which will please all stakeholders (A 5.6, M 2.4).
2. Measure customer profitability and rank them as a guide to a number of programs and introduce the tracking goal of growing the annual profit per customer to an optimum level (A 2.3, M 3.5). The first sub-program should be managing the small order problem and shaping up or out the most extreme, losing accounts (A 2.15, M 3.8 - 3.11). This initiative will boost profits, free up personnel slack to either layoff another round of least productive employees or start on proactive efforts to achieve "perfect service" metrics for each customer niche.
3. Implement a "zero error program" with simple techniques that can work for a distribution center (A 3.9, M 4.5). This will again boost slack, profits, morale and customer satisfaction.
4. Start a learn-n-earn certification game which links merit wage increases towards a target premium wage that is based on what the marketplace pays for each front line service job. Cross-training is vital to maintaining low error rates and dealing with surges of both orders and in-bound receiving (M 4.7). Surges must be handled the same day or service metrics and customer satisfaction will suffer.

The internal productivity plays above will improve both target ratios, but sustainable, faster profit growth will require the additional customer-centric initiatives below:
1. Each distribution center must define its "historic #1 niche" by looking for homogeneous groupings of customers amongst the top 10 to 20 most profitable accounts from the ranking report mentioned above (A 2.3, M 3.3 &3.5). Then, the best accounts must be re-visited to better understand what "perfect service" is for them and where basic expected services end and extra services for fees begin (A 5.8, M 3.2). Service systems and education must be revised to give each customer niche exactly what they want - not more than they need or will pay for and not too little to drive them away.
2. Prices, terms and selling modes must vary with the size of the account. Annual sales per account boundaries must be set for the different possible modes of selling - outside sales, telemarketing, catalog/direct mail or cash-n-carry retail (M 3.6-7). Most distributors/channels that started with outside sales reps have too many reps calling on too many small accounts that could produce more margin dollars for less total selling costs using other selling modes (M 3.11). Buying out and reassigning smaller accounts from outside sales reps to other selling methods will boost the profit/customer ratios for both the reassigned accounts and the large ones to which sales reps should focus more time on to selling win-win systems.
3. All employees must memorize both the most profitable and the most important target accounts to be able to say "Yes" on the spot to whatever these customers might ask for (M 4.9). Management must team sell both groups with salespeople to earn lucky breaks for upside volume. Over the next 5 years, 10 or fewer accounts will account for 80% or more of every distribution center's sales and profit growth. Which ones are they and what is the total team doing for them (A 4.7, M 3.7)?
4. To win more sales at higher margins or better total profits from all customers, the "perfect service journey" must be traveled (M 4.1-13). The steps are: defining perfect service for each target niche, measuring it, achieving it, selling it and getting paid for it in one of two ways. When customers ask for a price to be met and/or lowered or an equivalent concession, we should eventually be able to say -"Give us last look plus something more as a fair share of the incremental, total procurement cost savings that our service quality has delivered. Or, if you want lower, every day prices, then let's talk about putting all of your purchasing for a given logical area into a win-win system so that are total sales/service costs can drop to afford the price reduction." (A 2.5, M 4.12-13).

Trying to save your way to a stable or lower PPR ratio will aggravate the following doom loop. Pay little to get little; achieve undifferentiated service; be a price-taker with higher, invisible customer defection rates; have poor profits; go back to "pay little."

Trying to maximize GM$/person can kick-off a virtuous cycle. Pay more to get more: sign up everyone to learn about and execute both the productivity and customer profitability plays above. Grow GM$/person, profit/customer, sales and profit growth rates; promote from within; repeat. All stakeholders win in both the near and long term (A 3.3, M 3.12).

Need more "good-to-great" catalysts to get going? For education, the book by the same title is excellent. Consider the videotape, "High Performance Distribution Management Ideas for All" - details are at www.merrifield.com. For "informating" the high performance environment at each distribution center, companies will need a re-purposed and re-tuned "business intelligence system" that will allow local, process input numbers to get trend results that all must share. These tools are sometimes available as add-on modules from ERP vendors and have been called "executive information systems". Larger chains can afford custom integration solutions into their legacy system. "InControl" from Informediate is an example that is available both ways (www.informediate.com).

Now is the time to embrace high-performance, service management methods and manage the true profit causing ratios. The 2002 economy will be brutal on those who try to incrementally manage financial symptoms. And, when the economy starts to expand again the doom loopers will see their best employees once again leave for the zoom loopers. The rich will get richer and the rest will continue to fade away in all consolidating distribution channels.

1 Good to Great by Jim Collins. HarperCollins, 2001.
2 Parentheses with letters and numbers throughout this article refer to "A" for numbered articles found under the "articles" tab at www.merrifield.com. "M" is for numbered modules within the video, "High Performance Distribution Ideas for All" - summaries at www.merrifield.com.
3 The report is authored by Al Bates, President of the Profit Planning Group of Boulder, CO. Phone: 303/444-6212, or email to: info@profitplanninggroup.com. Mr. Bates' company used a database of ten year's of financial performance data from over 10,000 distributors from 40 different distribution channels to glean new insights into distributor profitability. It is available for purchase at www.nawpubs.org.
Merrifield Consulting Group, Inc.
D. Bruce Merrifield, Jr.
January, 2002