Bottom line basics

There is a world of difference between turning an operating profit and making enough money to survive. Channel players pre-occupied with top line sales growth need to pay more attention to the bottom line basics.

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By  Stuart Wilson Published  June 5, 2004

There is a world of difference between turning an operating profit and making enough money to survive. Channel players pre-occupied with top line sales growth need to pay more attention to the bottom line basics.

Too many fail to realise that operating costs and wages need to be factored into their business model. A trading mentality continues to persist in the Middle East IT channel, meaning some companies will buy product in at one price and sell it out at exactly the same level or with only the tiniest of margin attached.

Doing these deals makes the top line sales figure look great. And in the absence of published financial figures for channel players in the Middle East, some distributors and dealers love to allude to their size and power by bandying around an annual sales figure based on last month’s run rate. In some cases these are pretty impressive numbers, but at the end of the day it means nothing. Zip. Zero.

What matters in the IT channel is profit margin: making a reasonable percentage on every deal, allowing the business to cover its operating costs and still pull in some profit on top. This should be the focus for every channel business harbouring long-term ambitions in the Middle East market.

At a distributor level, the toughest task is often educating the sales force to reject the deals that make no financial sense. The fear of losing a deal to the competitor down the street prepared to drop his price may be difficult to swallow. Ultimately though, this is the sound business decision to take. If one distributor can’t make enough margin at a particular price point, it is highly unlikely that his rival will be able to.

Those that do drop prices below the comfort level soon get sucked into a world of having to maintain cash flow to pay off the vendors that supply them. Eventually, this desire to make the trade develops into a self-propagating cycle of deal-making that papers over the underlying cracks in the business model. Those cracks remain under the surface, masked by the top line growth, but widening every day and lying in wait for the moment when the business becomes untenable. The eventual collapse is a swift process.

In certain sectors of the Middle East IT channel the desire to trade continues to overshadow the need to make a profit. It only takes a couple of players to pursue this policy in order to drag everyone down into a world of zero margins where it is difficult to see how anyone can ever emerge a winner.

There is a real danger of oversimplifying these issues. Some channel players may take a loss leader on certain products in order to make up the margin on related sales. Others may pursue a low-cost strategy to increase sales volume and enhance their position when it comes to negotiating purchase terms with major vendor partners. Both valid reasons for a short-term price reduction on certain products or lines, but neither is a justifiable cause for inflicting long-term damage on the business through a heavy discounting strategy.

A lack of financial transparency also hampers any evolution towards a business model where margin takes priority over sales. Financial figures may not be available to external observers, but they are clearly available internally. These figures should be pored over to discover what parts of the business make a reasonable margin and those that do not. Then it is necessary to take some tough decisions.

Equity analysts covering quoted channel players in Western Europe and the US pay more attention to margins than they do to sales. A distributor with sales of US$100m and operating margins of 10% is much more appealing than a US$1bn distributor with margins of 1%. Both companies are posting operating profits of US$10m a year, yet the larger player is in a much riskier position because a minor shift in pricing could wipe out its entire profit pool.

Making the shift towards sustainable margins requires buy-in from distributors and dealers across the board. It only takes a couple of desperate players quoting a few silly prices to drag the whole sector down. Clever players bow out gracefully from the deals that make no sense. Those that remain at the table are already playing on borrowed time.

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