Do you know what keeps wholesale distributors awake at night? It’s margin, it’s their motto, their fear, and their hope.
Margin is the most critical metric for a wholesale distributor. It is a well-kept secret as valuable as the formula for Coca-Cola. In fact, there are only a few people in an organization that know and understand the real margin. However, there are a few definitions of margins that have generated some confusion. Let’s look at the few of the most important types of margins:
The Pocket Margin
Sales representatives have a window to negotiate the sales price called “pocket margin” that they can work within. The pocket margin is the Net Sales Price minus Cost of Goods Sold (COGS). Pocket margin also known as gross margin, but it is not often the true margin, it is only a line the sales rep cannot cross.
Inside the pocket margin formula, the net sales price can have two different versions:
The list sales price minus all sales discounts and applicable promotions on an invoice
The list sales price minus all sales discounts and applicable promotions on an invoice including any contractual based rebates not appearing on the invoice. This is also known as the net/net sales price, or double net sales price.
COGS, which normally represents the cost of manufacturing, is what the wholesale distributor considers the purchase price since distributors do not manufacture.
The average net purchase price includes all discounts applicable from suppliers including any contractual based rebates not appearing on the supplier’s invoice
The distributor might artificially increase the above price to their sales reps to keep the actual Pocket Margin confidential
The term Pocket margin is often used for one transaction, and the gross margin is for a larger scope of transactions over a longer period of time which may also include periodic fees (like the ones Amazon charges for its Prime members) on invoices to customers and suppliers.
The Net Margin
In order to get to net margin, a cost analyst takes the “true” gross margin as the basis and substracts the marketing, sales, logistics and administrative costs, which may be applied to separate cost centers to arrive at the overall Net Margin for the wholesale distributor.
Marketing costs include marketing initiatives either captured by business unit cost center or spread across all products sold
Sales costs include travel, wages, and incentives of your sales force and get applied to a hierarchy of cost centers representing different sales teams inside the various sales departments
Logistic costs include the warehouse cost, transportation cost inbound and outbound, as well as the cost for broken, lost, and returned products
Administration cost include all costs for corporate, local offices and support departments.
The Precision Net Margin
However, available data today allows for more precision in ascertaining the net margin. Finance and executives like to know the net margin by sales team, geography, customer, product category, and even by the product. In some cases, there may be alerts on specific margin destroyers.
To find the margin destroyers, the above costs need to be accounted for according to product and customer hierarchy. However, this cannot be done at the transaction level because the cost is NOT captured at the sales order level and these indirect cost are attributed to the various cost centers.
Then you need disaggregating keys to allocate costs to each customer, product, and geographical segment to drill down to the true cost. The choice of the keys can be a huge challenge – but an analyst will be able to use any data represented to choose the keys. For example, for transportation, your first key would be to disaggregate the cost, considering the weight and distance of the customer. You can then split and allocate the logistic costs to the different customers and product hierarchy.
This will give you the Precision Net Margin (PNM) which will identify the margin destroyers that you need to transform into margin makers. For example, if you sell the same product at the same price to two customers, one close to your distribution center, and one at a distant location, the one at the farther location could end up being a margin destroyer due to the shipping costs.
Wholesale distributors have the same challenges as other industries to ensure the various margins stay above the line. Nevertheless, there are two questions for a wholesaler to consider:
Have you included any contractual rebates on the sales side and purchase side?
How deep do you need to drill down on the PNM to discover your margin destroyers?