The ABCs of ROA: maximizing performance
You hear it in sports, you hear it in business—you even hear it on daytime television talk shows: success begins by focusing on the things within your control.
Against a backdrop of difficult market conditions and during the recent Northeastern Retail Lumber Association’s LBM Expo, consultant Matt Kay from Boston-based consulting firm Vitale Caturano turned to this popular advice for the home channel, specifically as it relates to return on assets.
Sales and profits get more press in the business pages, but a company’s return on assets is a great place to begin a business review in tough times.
Using both sides of the balance sheet, Kay drew up a test case that showed how improvements in sales, gross profit, expense control, inventory turns and accounts receivable can push the need significantly.
“This cycle is not going to last forever,” he said. “The businesses that are effective at managing their cash flow, managing their margin, managing their turnover are businesses that are going to prosper in the next five to 10 years.”
Mixing benchmarking data from the North American Building Material Distribution Association (NBMDA) with business advice, Kay described cost cutting as “a game of inches.”
Kay defined ROA as the ratio of earnings before tax to total assets, expressed as a percentage—or more generally, the measure of how an individual company makes the most of what it has. His advice attacked each of the variables in the ROA equation. He talked about making some marginal improvements in each of the functional areas of the business. Those minor improvements have a significant impact on the performance.
Always be selling. In tough times, it’s simply unrealistic to expect companies to bear down and boost sales by 10 percent. But there are things companies can do—including going after commercial, hospital construction, schools—and get the sales team integrated in some of these development projects. Also, installed sales represent an opportunity in particular as Expo Design Centers exit the market, he said.
“Sure we can lament the depressed home construction market, but we have to find ways to go after new opportunities,” he said. “Certainly the market is tough, so in reality it’s more of a preservation strategy.”
Boost margins Kay pointed to NBMDA research that showed the average margin for lumber dealers is 26 percent of sales, which he described as a “red flag.” The big boxes come in at about the 29 percent or 30 percent level.
A small percentage point gain in margin leads to a huge impact on ROA and profitability—he showed an example where three points doubled net income and more than doubled return on assets.
Of course, boosting margin is easier said than done (See sidebar.) Kay’s recommendations begin with identifying the 10 leading margin producers in the store, as opposed to the 10 leading sales items. Also, pick your spots carefully to engage in price optimization. “Take a look at the c and d items, because those are going to be under the radar for most folks.”
Explain expenses As a percent of sales, the average lumberyard spends 24 percent on operating expenses, a relatively lean figure. It can improve. Specific advice includes targeting the right audience when advertising. And the big picture is to communicate to employees the effects of their company purchases.
Kay apologized for being the master of the obvious, but he added: “It’s really a game of inches here.”
Recognize cash is king. Smart purchasing with effective demand forecasting is a critical first step in the cash cycle, he said.
Collect Return on accounts receivable. “Become more engaged in collections,” he said. “The most persistent suppliers will get paid first.” If that means using sales resources as account receivable resources, then so be it.
Turn inventory The average inventory turn rate for lumber dealers is seven times per year, according to the NBMDA’s data. One common mistake that limits turn is running out of stock in top-selling items. “Don’t try to micromanage your top sellers,” he said.
In addition to getting rid of “dog” items, he cautioned against falling into the too-many-skus trap. It’s often easier for employees to gain expertise in a category with a smaller assortment.
“One thing you might find is if you carry smaller assortment, your sales people are far more educated on the products that you do carry. They’re going to make people feel comfortable about them.” And that expertise, if marketed properly, can help boost turns.
The overarching idea behind turn improvement is to put your capital to work in more effective way, thereby boosting ROA.
Obviously, boosting ROA is easier said than done.
“You have to keep a close, close eye on each of these aspects of the business to drive maximum performance,” Kay added.
MARGINAL IMPROVEMENTS“When you look at marketing in a recession, you have to look at programs and opportunities where stores can get full price and add value,” said Steve Frawley, CEO of hardlines distributor Emery-Waterhouse.
What products fit the margin-boosting bill? Green products, tankless water heaters and “the energy-saving side of the product spectrum,” he said.
Frawley also pointed to the margin boosting potential of name brands. “As the market expanded, everybody was driving after low cost, enhancing margin but enhancing at the expense of the end user,” he said. “We’ve generally stayed with the brands—the Stanleys, the Newels, the Irwins. It’s important to focus on turnover and higher productivity at the retail stores.”
Dealers often talk about opportunities in showroom retailing, in green building, and of course, new products.
During a recent Builders FirstSource conference call, senior vp and CFO Charles Horn was asked point blank to rank the profitability of the different market segments. His answer: windows and doors, millwork, other products and services, manufactured products and—in last place—commodity items such as lumber and panels.
“If you look at the areas where gross margins have held up, it’s still going to be in your windows and doors, millwork and your other products and services,” Horn said.
Manufacturers have plenty of ideas about margin opportunities, including selling up and selling more efficiently, and they were on display at the recent International Builders’ Show.
“There’s a higher dollar margin, but the opportunity comes in when the dealer can sell [additional] features as an option,” said Chris Simpson, senior vp-sales and marketing for Pella. Examples he gave on windows are Low-E glass, blinds or shades between the glass.
At Georgia-Pacific’s booth at the International Builders’ Show, one message was the efficiency built into the Nautilus exterior sheathing that combines OSB and building wrap, saving builders time. (They only need the framing crew, not the house wrap installers.)
“The dealers are looking for something to differentiate themselves,” said Duane Smith, regional manager, engineered lumber, BlueLinx, which distributes the product for GP. “If you can save the builders two days, that’s huge.”
Smith also points out that Nautilus, which costs more than regular OSB, costs the same amount of money to transport and deliver. So naturally the dealer would rather sell a truckload of Nautilus than cheaper OSB. “The drivers, the insurance, the fuel—it’s the same no matter what you’re hauling.”