Thursday, December 22, 2016

An unconventional idea and the unconventional management accounting behind it.



It was Joseph, the son of the founder Clemens, who came up with this unconventional idea: "You can cut your profit mark-up dramatically. Even with a lower margin, the far greater volume of sales will still boost the bottom-line profit." The question the third generation of C&A entrepreneurs faced was, "How can you see whether an article with a gross margin % below your average cost percentage is profitable?" Their answer was: Calculate the contribution per unit in stock per year = $Margin x TOS

Here is the story of how they figured this out.

From the book Vier Generaties Snekerkring : "The year 1906...There was no off-the-peg clothing for the masses; the entire industry catered to the top segment of the clothing market. For example, in around 1900 a coat (at C&A) cost many times the weekly wages of an average labourer and was beyond the means of domestic servants, who often worked for just board and lodging.
Leafing through the tax register of Amsterdam- in those days it was a considered a privilege to be in it-it occurred to Joseph (Clemen's son) that every clothing store in Amsterdam, including C&A, was targeting just 4% of the population. The remaining 96 per cent could not afford to buy from them. If you could include those 96% in your target group, you could cut your profit mark-up dramatically.

Even with a much lower margin, the far greater volume of sales would still boost the bottom-line profit!


Joseph saw unprecedented growth opportunities beckoning on the horizon.
Joseph reasoned that the only way to win the custom of that part of the population, that 96%, was to base your prices on the average weekly wage of the man in the street, which at the time was about six guilders (2,75 euros). So it happened that C&A started offering coats of reasonable quality for no more than six guilders. ...
It was a knock-out success. From day one the coats flew out the window. During the first few days there was such a surge of demand that staff at the store seemed likely to be overwhelmed. Joseph decided to take action, so he sent a telegram to his cousin Georg in Leeuwaarden:'Please send sales assistants.' Georg didn't pull any punches in his reply:'If one opens a store, one should be properly prepared.' But in the end some sales assistants were sent from Leeuwaarden to help out in Amsterdam. It's easy to imagine how overwhelming it must have been for them...
The repositioning of the C&A formula in Amsterdam was the first step towards future years of exceptional successes. "

Joseph made a lot of money in his store and always refused to even discuss selling coats for more than six guilders in his store. His cousin Georg in Leeuwarden never switched to C&A Amsterdam's new low margin strategy, but they worked relatively independently and so it was never a problem.

During the depression, the Dutch company Voss experienced major problems and sought help. Voss also sold coats but in another part of town and targeted a totally different 'better' segment of the market. After careful consideration, C&A took over the business in 1934. The stores continued to operate after comprehensive restructuring.

Now the third generation was faced with a situation in which coats with very different margins and selling prices were sold in one concern. When the profit and loss statements were consolidated it suddenly seemed like the coats sold by Voss were more profitable and the coats sold by C&A were making a loss ! When considered by conventional retail accounting where the profit mark-up percentage has to be higher than the percentage of costs, normal managers might have made the wrong decisions for the future.

Let's look at C&A's numbers before consolidation:

C&A store selling Josef's black coats
$6,- selling price per coat
-$5,-buying price per coat
--------------------------
$1,- margin or $1/$6 = 16,7% profit margin
100 000 coats sold in one year
$100 000,- gross profit ($1, x 100 000)
-$50 000,- store rent
-$25 000,- labor and staff costs
---------------
$25 000,- bottom line profit

Voss was making a loss with his more expensive coats with a higher profit markup. Let's consider his profit & loss statement.

Voss's store selling expensive coats
$12,- selling price per coat
-$6,- buying price
-------------------
$6,- margin or $6/$12= 50% profit margin
10 000 coats sold in one year
$60 000,- gross profit ($6, x 10 000)
-$50 000,- store rent
-$20 000,- labor and staff costs
---------------
-$10 000,- bottom line LOSS

Consolidated store profit & loss

$720 000,- Total sales
-$560 000,- Buying price
-------------------------
$160 000,- Margin, 22,2% gross profit ($160 000/$720 000,-)
-$100 000,- Rent
-$ 45 000,- Labor and staff costs, 20,1% selling costs ($145 000/$720 000,-)
--------------------------
$ 15 000,- Bottom line profit, 2,1% net margin ($15 000/$720 000,-)

Stores plan their average gross margin % based on their past performance, goals and expectations for the period ahead.
If a store in a certain year had a gross margin percentage of 22,2% of sales and the selling costs of running the store were 20,1% of sales, the net margin would be 2,1%.

For most clothing retailers this would be unacceptable, a consultant might be called in and a decision might be made to increase the gross margin percentage from 22% to 25% of sales.

The product mix contains 2 products:
Joseph's coats with a profit mark-up of 16,7% and Voss's coats with a profit mark-up of 50%.

Which coat is contributing more to the store's profits ? Remember Joseph's coats are marked up at 16,7% and the store's costs are 22,1% of sales, while Voss's coats are marked up at 50%. It looks like Joseph's coats are loss leaders, because the margin is lower than the cost of selling. What would happen if a buyer suggested replacing Voss's coats by more even more expensive coats with a profit mark-up of 10%?

The third generation of Brenninkmeijers realized there was no link between an article's gross profit markup percentage and it's bottom line contribution (boost).

Their management accounting system (similar to GMROS) was based on a product's contribution to profit.

For every style or order in stock you could calculate the contribution per unit (ie. per coat).

Contribution per coat in stock per year= $Margin x TOS
$Margin = selling price - buying price
TOS = Turn Over Speed = units sold per year / average stock

Both stores were the same size and could present 1 000 coats on the shopfloor.

The consolidated store thus presented 2 000 coats, 1 000 of Joseph's and 1 000 of Voss's.

Contribution per coat = $margin x TOS
Joseph's coats = ($6-$5) x 100 000/1 000 = $1 x 100 = $ 100,- /coat/year

Voss's coats = $12-$6 x 10 000/1 000 = $6 x 10 = $ 60,- / coat/year

Total contribution = SUM of CONTRIBUTIONS ($ 100 x 1 000 Joseph coats) + ( $60 x 1 000 Voss coats) = $ 160 000,-

When Joseph (and later generations of Brenninkmeijers) used contribution calculations, they could make the right decisions and leave the competition who used gross margin percentage driven decision making in the dust.

Consider for example the buyer who suggested stocking expensive coats at a 10% profit
markup, eventhough last years costs were 20,1% of sales.

The buyer suggested selling coats for $ 19,99 which had been bought for $ 18,-. (The competition sold similar coats at a 50% profit markup for $ 36,-).

What would happen if they replaced Voss's coats with these more expensive but lower margin "Keurklas" coats.

Contribution per coat = $margin x TOS = ($margin x Units sold) / Stock

How fast do I have to sell the "Keurklas" coats to beat the Voss coat's contribution?
TOS = Contribution per coat / $margin

The $margin is $20-$18=$2
TOS (Turn Over Speed) = $ 60 (Contribution Voss) / $ 2,- (Keurklas $margin) = 30 turns per year needed to add more contribution than Voss's coats.

They decide to order a few of the Keurklas coats and sell them as a test. The coats sell at a TOS of 45.

Contribution = $margin x TOS = ($2 x 45) = $90,- euros per coat per year

They replace the 1000 Voss coats in stock (50% profit markup) with 1000 Keurklas coats (10% profit markup).

Total contribution = ($ 100 x 1 000 Joseph coats) + ($90 x 1000 Keurklas coats) = $ 190 000,-

--------------------------------
Profit and loss statement Joseph + Keurklas coats

$1 500 000,- Total sales
-$1 310 000,- Buying price
-------------------------
$ 190 000,- Margin, 12,7% gross profit ($190 000/$1 500 000)
-$100 000,- Rent
-$ 45 000,- Labor and staff costs, 9,7% selling costs ($ 145 000/$1 500 000,-)
--------------------------
$ 45 000,- Bottom line profit, 3% margin ($45 000,-/$1 500 000,-)


End of this story.

The fourth generation set up different brands for different customer segments, but behind the scenes C&A teams bought and sold items at three price levels: High, Medium and Low. Top management set average gross margin targets (BCP%) at levels significantly lower than the competition was using, but at about the same percentage for the different pricepoints. The amount of stock allowed (and thus spaced allocated) was managed by setting high TOS targets for Low priced articles and lower TOS targets for High priced articles so that the contributions ($margin x TOS) were roughly equal across price points.

For example blouses
High $40 price x 25% margin = $10,- $margin, TOS target =5, contribution= $10 x 5 = $50/blouse/yr
Low $ 8 price x 25% margin = $2,- $margin, TOS target =25,contribution= $2 x 25 = $50/blouse/yr

======================================================================
Today and tomorrow (fifth & sixth generation):

Step 1.
Calculate the BOTTOM LINE CONTRIBUTION for articles that are selling at the moment. It is easy (and should be part of the reports buyers and merchandisers use).

The contribution per article per year = $margin x ((units sold per week x 52)/stock on hand)

You can compare every order (SKU or style) you are selling.

Step 2. Remove the average gross margin percentage target from planning and replace it with gross margin in euros targets (per square meter). And/or income targets per coat or pair of pants etc in stock.

Comments or E-mails are welcome.

E-mail: ajbrenninkmeijer@gmail.com

Mobile phone +31629547689

2 comments:

casper gockel said...

john je verteld ons eigenlijk liever centen dan percenten!
erg leuk met de historische data er bij.
groetjes

Ansgar John said...

That's right Casper cents instead of percents and costs allocated by space used ie. the number of units (coats) in stock.