The Illusion of Gross Profit
Have you been tricked by the illusion of gross profit?
The latest marketing program proposal was just laid out in front of you by a sales professional of a vendor that you’ve heard of in the past. The sales professional claims that many of their clients have seen big results in traffic to the store or website based on this campaign and you can’t afford to miss it. They may even claim gross profits for client X rose by $xx,xxx. Do you jump in and stroke a check today?
Well, after doing your research on the vendor, and campaign only you can decide that. But let’s say after thoughtful contemplation (as opposed to urgent “we have to more leads now!” mentality) you decide to execute the program at a cost of $10,000.
At the end of the month of the campaign, you look at your unit sales and gross profit and both are up, so it must be a great program, let’s do it again.
Let’s look at the illusion of gross profit.
Before I go too far let me state that the example I’m about to use is very real, the numbers are only rounded off for the ease of showing the example. The aforementioned campaign was executed and at the end of the month the dealership sold an extra 12 units over last month and earned an additional $25,600 in gross profit. Therefore the campaign must have worked; everyone knows an extra $25,600 in gross profit is a good thing. So let’s do it again right away.
Before you begin stroking that second $10,000 check, let’s do a little fact checking. Did you really get 12 additional sales from that campaign or were they simply a part of the natural rise and fall in sales that happens every month in the dealership? Just because you had more sales and more gross doesn’t mean that campaign was successful. If you don’t track your leads generated, appointments set, appointments kept and final sales including the gross profit for the specific campaign you can’t be sure if the campaign generated the additional gross profit. The gross profit could be just an illusion keeping you from looking any further. Don’t believe me yet?
Let’s say you did track the 12 sales to this specific campaign, did those 12 additional sales really generate the additional $25,600 in gross profit? I doubt it, but go make sure. You start digging and find that the 12 deals were lower grossing deals and only really contributed $16,000 in gross profit. The rest was simply your team doing a better job overall for the month in putting stronger deals together for gross profits
Now, you are pausing just a second to think before you stroke that second $10,000 check.
So you have determined that your 12 deals created $16,000 in additional gross but, what was the real cost of generating that additional $16,000 in gross profit? First you need to deduct the $10,000 you spent on the campaign so you have $6,000. How did those 12 extra units affect sales and sales management compensation? Most sales teams are paid based on units sold, and additional sales often cause larger tiered payments to be made. What did the sales team earn from the extra 12 sales? Also, the additional $16,000 gross profit most likely resulted in more compensation being paid to your sales management team as many are paid on variable ops gross profits. So once you know the sales personal additional cost and the sales management additional cost use a multiplier to factor in benefits and taxes that are attributable to the increase in compensation. Realistically, you probably have about $4,000 or more in additional expenses now to deduct from your gross profit.
So, your $16,000 has dropped considerably to $2,000 which is more accurately described as your net variable gross profit and we haven’t even talked about the cost of capital in inventory, contracts-in-transit or what percentage of your gross profit normally makes it to net profits.
Writing the check or not is still your decision, but at least now you aren’t focused on the illusion of gross profits. Hopefully, you are stopping to look at the items you need to evaluate if this campaign is something you can afford to do again. It’s too easy to look at overall gross profit and assume that something worked without looking at the true cost.
Don’t be fooled by gross profits, it’s not what we make in business it’s what we keep that keeps us in business.