LOUISVILLE, Ky.-It's a mirage that has lured nearly every dealer off course at least once: Namely, the temptation to shave prices while hoping to generate enough increased volume to more than offset the lower margin on each sale. Although it's possible, the probability of that strategy's success is remote, said speaker John Zito, director of credit for Coop-er Tire & Rubber Co., during the recent World Tire Conference & Exhibition.
``Don't believe that a discount in your selling price is going to allow you to make it up in volume,'' he advised at an April 18 seminar, ``Understanding the Financial Puzzle.''
A dealership would have to increase sales volume a whopping 66.7 percent in order to offset a modest, 10-percent reduction in its selling price, Mr. Zito pointed out.
To illustrate, he explained that if a dealer's regular selling price for a tire is $100 and its cost is $75 dollars, the gross profit on each unit sold is $25 or 25 percent.
Reducing prices by 10 percent will mean the same tire will sell for $90 rather than $100. Then, after subtracting the dealer's $75 cost from this lower selling price, the result is a $15 or 16.7-percent gross profit.
And since $15 goes into the former $25 gross profit 1.667 times, it will be necessary for the business to increase its volume 166.7 percent in order to break even.
The most effective way for most dealers to improve profitability is not by generating more sales volume-but by controlling existing expenses, Mr. Zito said. And any firm that could do two-thirds more volume without incurring overtime or other additional expenses is simply too fat, he added.
Most expenses fit into one of three categories-payroll, fixed and controllable. Payroll is the largest of these three categories and therefore the most productive place to set about controlling costs, Mr. Zito advised.
He said 22 years of experience have convinced him payroll and employee productivity is the most common factor in determining profitability-or the lack of it.
Payroll should amount to about 50 per-percent of gross profit, he said. When such businesses are profitable, they're adding dollar value-two dollars or more for every dollar of payroll expense. And the more that dealers exceed this benchmark the more profit they make.
Of the gross profit remaining, he said controllable expenses should account for about 30 percent and fixed expenses only 10 percent-leaving 10 percent or more for net profit. Therefore, particular attention should be focused on payroll and controllable expenses.
``When accounts receivable increase from $100,000 to $150,000, you are making a conscious decision to invest in your customers,'' he said. Allowing inventory to grow from $200,000 to $300,000 is a conscious decision to invest in inventory.
One of the most important retailing innovations brought by the late Sam Walton, founder of the Wal-Mart and Sam's Club chains, was a unique new form of computerized inventory control, Mr. Zito explained.
Atop every Wal-Mart and Sam's Club is a satellite dish by which data regarding how the store did that day is transmitted to company headquarters in Bentonville, Ark. There, employees put together a list of what each location will need the next day, then relay the data to regional distribution centers.
By 5 a.m., trucks carrying the necessary merchandise begin leaving the distribution centers en route to each store.
This way, by turning inventory every 16 days and collecting cash for merchandise on which it doesn't need to pay for 30 days, Wal-Mart has been able to operate on suppliers' money, which has helped fuel expansion.
A cash flow statement is perhaps the most important piece of financial information an owner or manager of a business receives from the firm's accountant, he said. It shows the amount of cash the business is generating-and where it is going.
``You can be profitable, and if you are running a negative cash flow you will go out of business,'' he told dealers.
``Profits may be the heart of your business, but cash flow is its life blood.''
One way of charting it is to total the average number of days products remain in inventory and the number of days that elapse from the time of sale to when the dealer actually collects his money.
Industrywide, he said, the average number of days the product sits in inventory is 60, while the average number of days between the time of sale and when the dealer gets paid is 45. Thus, on average, it is 105 days from the time the dealer purchases the tire until he gets paid for it.
So if his supplier is giving 90-day terms, the business's owner must be prepared to finance the remaining 15 days. Should the merchandise be allowed to remain in inventory for 90 days rather than 60, that 105-day waiting period increases to 145 days.
``It costs you 3 percent a month to carry inventory,'' he said. So if the merchandise you're considering doesn't sell for four months, it's going to cost you 12 percent to carry it for that period. Therefore, purchasing it may be worthwhile unless the supplier's discount is more than that amount.
Dealers must decide ``what's in your best interest,'' he said, when it comes to accepting or turning down what suppliers offer.
Mr. Zito cited a National Tire Dealers & Retreaders Association study showing that most dealers average $1.51 in assets for every dollar of current liabilities. This falls below the $1.65-to-$2 range most experts consider desirable, he said.