This week’s guest article is from Daniel Murphy, Co-Founder and Managing Principal of Strategic Choice Partners. Dan has over 30 years of experience holding senior finance and operating roles at TJX, Pepsico, Panera Bread, Princess House and Immunotec. For the last 15 years Dan has served as both a CEO, CFO and COO for two party plans and network marketing company respectively. Currently Dan is a consultant specializing in the direct selling industry. Dan also served as the Treasurer of the Direct Selling Educational Foundation and previously served as the Treasurer for the US Direct Selling Association.
Guest Post by Dan Murphy
How Direct Selling Companies Can Conduct a Straightforward Financial Tune-up
Anyone who is a veteran of the direct selling industry generally loves the industry. This is one of the few business models where you can do good while you do well. Executives have the honor of offering an opportunity that has the potential to change people’s lives for the better. It is also a responsibility to make sure that the opportunity remains viable over a very long period of time.
For this reason, I find it necessary to conduct periodic financial reviews for direct selling corporations, to safeguard a company’s position and to ensure its long-term success and viability. I’ve conducted dozens of these reviews over the years, and I’ve never once had a review not results in a significant positive results to the bottom line.
I’m also always surprised at how many direct selling companies do NOT go through this exercise of what I call a financial tune up. So that’s why I want to introduce the concept to you in this article.
So what is a financial tune up? It is a detailed review of the Key Performance Indicators (KPIs) of a company, as well as a review of the various financial cycles. KPIs include the metrics that result in revenue and growth within a direct sales company. Financial cycles include Revenue, Inventory, Margin, Freight and Distribution, Information Technology and General Overhead.
A complete review requires a session of key stakeholders with the organization over a period of typically about two days, provided the proper historical and current data has been assembled in advance. The goal is to examine KPIs and each cycle to determine if industry standard benchmarks are being achieved or exceeded, where there is a gap, and determine steps to achieve or exceed industry benchmarks.
This is a very disciplined approach, but it pays off in the end. You’ll find that over time certain assumptions have been made which are actually excuses for suboptimal performance. Some of these assumptions could be:
- Our customers will simply not pay freight rates equal to our costs so we subsidize lower freight rates in order to grow the business.
- Once we achieve scale we will be able to purchase products at lower costs allowing us to achieve profitability. Until then, we will lose money.
- The current overhead is a long-term investment that will help us grow rapidly once we hit break even.
- The KPIs will improve if we could only find a good field development leader to run our sales efforts.
- Yes ,we have a competitive compensation plan which we copied from (insert current rising star company here), but the margin in our products less the payout of the plan doesn’t produce adequate dollars to support even minimal overhead. How does Company X do it and we can’t?
- You don’t understand, we are not like any other direct selling company. We are unique and the industry standards just don’t fit us.
These are simply a handful of the statements over the years that I have heard executives make in support of the current status quo. If you believe and hold tightly to any of the above statements, as well as any other number of excuses, performing a financial tune-up will be a waste of time. If you are ready to examine honestly every component of your business that you will find great benefit in going through this type of exercise.
So let’s get started: Step one is the review of all KPIs. First, do you have KPIs? Many companies I work with know what KPIs are, but they don’t actually have them in place and track as a way to manage their business. Examples of KPIs include the sponsoring rate, the retention rate, activity rate, orders per active, average order size, paid as leadership statistics, reorder rate, auto-ship average life, fast start achievement rate, performance of each months new consultant class, event attendance, % of attendees that actually order. If you don’t have KPIs, the first step in a financial tune-up is to agree what KPIs are important for your business and a commitment to start tracking them.
Once you have your KPIs identified, track how have they been trending over time and what are the root cause of changes, whether positively or negatively. Set concrete goals that are tied to actual financial outcomes. Determine what the life time value of a new consultant joining your business is. This will drive decisions regarding support for sponsoring initiatives, as just one example.
The revenue cycle review should include a line review. A line review looks at each and every product in an objective manner, which calls for a judgement as to what it’s reason for being is. In order to conduct a proper line review, SKU and style history is needed. In most company’s 20 to 30% of the merchandise drives 70 to 80% of the revenue. What is often discovered is that the product line is bloated, and poor performing items remain in the line due to high inventory levels, or because it is a top leader’s favorite product.
Poor performing items need to be identified, and a specific plan put in place to eliminate the items over time. This is a tough process, but you must challenge yourself to establish concrete measures for success. In addition, new items or planned new items should be reviewed to determine if the margin in the items meets the overall objective. Lastly, a pricing review should be conducted again with margin objectives in mind. The outcome of this review should be implemented at the earliest possible opportunity, usually at the start of a new season.
Inventory control and management are crucial elements for success and should also be reviewed, generally this review coincides with the revenue review. For this section, an inventory aging report should be prepared. Old and discontinued inventory does not appreciate with age. Tying up capital in bad inventory can be a serious drag on a company’ success. This cash is better to be freed up to invest in other parts of the business—everything from technology to human capital.
One of the most critical and common issues I see at both small and established companies is what I call “betting on the future”. Entrepreneurs start their business but quickly learn that the key to a successful business is to have an adequate “X cost multiple”. In a typical successful business, this multiple is anywhere from 6 to 10 times the cost of the products. Let me repeat: That’s 6 to 10 times the cost of the products! This level of margin is necessary to fund a competitive compensation plan.
If the compensation plan doesn’t provide adequate rewards, it will prove impossible to attract and retain a sales force. The error that I mentioned previously is that a start up often doesn’t have the purchasing power with its suppliers to get the cost required to power the model. Many founders make the decision to start with a cost multiple of 4 or 5 with the idea that as they get to scale they will be able to get better pricing from vendors. This is a fine concept, but then the initial losses from operation will need to be funded from seed capital. Any company that is following this philosophy while at the same time boot strapping their launch will inevitably fail.
We now come to the cost side of the equation: I refer to any direct selling company actually operating multiple profit and loss centers. What I mean by this is obviously there is a P&L for the sales of actual products to end consumers. In support of that, there are other profit loss areas: Freight charges and cost of delivery is a separate business that needs to stand on its own; printed matter sold to consultants and the cost to produce that printed matter; fees charged for information technology and the cost to deliver that technology. In the case of a party plan company, there is the hostess program which includes all the benefits provided to someone acting as a host or hostess. All of the items that I just previously mentioned have to run at a profit. It is the responsibility of management to measure and take action to bring each of these areas into a profit position.
I am going to go deep on one of these areas mentioned above: Charges for freight. This is often a sore subject—we all here about e-commerce companies that offer free freight. A successful direct selling company will charge enough to cover their actual cost of freight as well variable warehousing and the direct cost to process an order. Management needs to know their costs as well as their package profile. One way to ensure that you are getting a good deal from your carriers is to work with a respected auditing and negotiating partner as a third party (let me know if you would like recommendations). I have seen in case after case where, at no cost to the Company, this third-party expert finds opportunities in freight costs. I personally know of one company which has saved over one million dollars over the last four years in lower freight cost directly due to negotiations that were quarterbacked by one of these companies.
There are a number of ways to make adjustments to this cost structure without causing a revolt from your field leaders. In one case, I worked with a company that shipped very heavy products. As a result, the freight charged to the end consumer was significant because they made sure that they more than covered their costs. However, the “freight issues” were a concern for the field. After careful review and consultation with leaders, they came upon a unique solution. They brought down and simplified freight charges while at the same time boosted morale and increased the rate of sales by a factor of 40%. They added two dollars to the price of each item, which was non-commissionable. The commissions to the field remained exactly the same as they were prior to the change, but the cost of freight to the end consumer was reduced by as much as 67%. The field was over the moon excited with the change, and sales went from plus 10% to plus 16% immediately following the implementation of the change.
Once again, the same posture as presented in terms of freight cost and charges needs to be established with printed matter, information technology and the hostess program in the case of a party plan company.
Finally, let’s talk about general overhead, or SG&A. These are all the other costs that have not been previously covered. Typically the largest element in this category is people to man a home office and executives to run the company. There are, of course, secondary buckets of cost such as credit card discounts in order to have a merchant account, printing costs, fixed warehousing costs, all utilities including telephone, heat, light, internet connectivity, etc. This is an area that needs to be watched carefully and managed skillfully. My advice is to run as lean as humanely possible at all times. I am not suggesting to be penny wise but pound foolish. But I’ve seen too many companies increase their costs too quickly, only have to make drastic cuts later when it could have been avoided.
In summary, there is a tried and true model to success in this industry:
- Set and manage to KPI objectives.
- Sell products that are 6 to 10 times their cost.
- Offer a lucrative compensation plan that supports sponsoring.
- To the extent possible, keep your costs variable by using outsourced resources.
- Tightly manage the overhead.
The outcome will be a profitable company from the outset. I am a firm believer that a direct sales company can be profitable at almost any level of sales if you’re diligent in managing your finances.