A CONCEPT'S ECONOMIC MODEL is the engine under the hood. You do not see it, but it makes the enterprise go. Without a good economic model, your concept will just spin its wheels. The degree to which entrepreneurs understand the economic model and the related financials varies with their sophistication. Some people understand a few components of a profit-and-loss (P&L) statement but do not understand the ultimate profitability. Some people understand what the numbers mean financially but do not understand how the numbers directly relate to the physical operation of a store. A few people, usually CEOs and senior executives of successful chains, understand the intimate bond between the operations and financials and how to connect the one to the other. Their understanding of the unit economic model is a major reason for their success.
Other people may think they “know” the model because they have been in general business or some part of retail for a long time. However, a new concept can have a different expense or income structure than what people are used to. Other people who should understand the financials in broad terms—the real estate people, design staff, contractors, and new store managers—seldom have a good grasp of the P&L. Suffice it to say that there are very few true connoisseurs of the economics of a concept. This chapter highlights the most important aspects of the financial statements with a focus on two points: 1.) how to develop a meaningful financial model and how that model can help you evaluate the performance of the underlying model; and 2.) how a successful economic model can fuel growth. Minimize your downside, and maximize your upside. That is the goal of the financial analysis of every decision you make in creating and executing on a concept. Whether ensuring that a new concept is on a solid economic footing or recalibrating the economics of an existing concept, the financial analysis enables you to establish the economic viability of the business and set the stage for expansion. Proving the economic model is a large part of proving the concept.
The economic model has to be robust enough to generate excess cash that can power expansion. Every store must be treated as an investment geared to generate cash. This requirement means that the primary numbers that a retailer needs to focus on are gross margin and net income. There is no other way to proceed but by jumping into finance terminology. Gross margin is revenue minus the cost of goods sold (COGS). More simply, gross margin is what you have in your pocket after you have paid for your goods but before you have paid for your operating expenses, which are often collectively called the cost of selling. Assuming a similar product mix across the chain, the gross margin for each store is roughly equivalent to the chain's gross margin as a whole, and so one number can stand for both. Net income (described in detail in this chapter) is gross margin minus operating expenses and depreciation. It is what is left in your pocket after you have accounted for the rest of your costs. A chain rolls up net income from each store and deducts corporate general and administrative costs (G&A) to return the chain's overall net income. An individual store's net income, then, will be 6 to 10 percent higher than the company's overall net income because of corporate G&A expenses that come after the money goes to headquarters. This chapter focuses on the net income for each store. For small retailers, corporate G&A is minor, and for chains big and small, store net income is the primary engine of growth.
A healthy gross margin is needed to provide oxygen to survive and grow, because things go wrong all the time in operations. Construction delays cause you to open late and miss your high season. You have a problem with store personnel and sales sag. The sidewalk gets torn up and sales drop for a week. Your computer or phone system goes on the blink. A snow or ice storm closes you during a peak holiday weekend. A hurricane strikes. In retail, Murphy's law prevails, and many of the things that go wrong are out of your control. A retailer needs every possible hedge against the downside, against unexpected increases in rent or labor and other unforeseen expenses. High gross margins (or, correspondingly, high volumes) give you more ability to adapt to the unforeseen and to deal with problems and mistakes and still have a decent net income. Thus, while your concept may not have inherently high gross margins, you need to know what others in the category average and ensure that your concept does not fall into the bottom of the range. Buying in small volumes through jobbers and distributors, new retailers seldom get the best deals. New retailers do not always recognize how thin their margins can be, and how little cash they will have to pay for the unexpected.
If your gross margin is below the industry norm, you should examine the COGS and reevaluate the economic model. One step, discussed in detail in Chapter 6, “Merchandising: Maximizing Your Profits,” is to change the product mix to achieve higher margins. Another is to exploit competition between suppliers. Perhaps you plan to sell a certain brand of shoe but another supplier has a comparable offering at lower cost to you. Restaurants can reduce costs by buying raw ingredients and preparing dishes instead of buying, say, prepared soups and bread. Because chefs or food preparers will be working on other dishes anyway, a few additional “homemade” items will not necessarily add to labor costs. Being careful about COGS does not mean to go with cut-rate products unless that in fact is your niche. Being careful simply means that retailers should wring every possible penny out of COGS.
A labor-intensive concept, such as food service, needs a higher gross margin to cover the still-to-be-paid labor costs, whereas a less-labor-intensive concept, such as an automated car wash, can get by with a lower gross margin and still return a good net income. Happy is the retailer who can set arbitrarily high gross margins, but the “invisible hand” of the market creates limits. A gross margin that results in an item being overpriced will result in few if any sales; overall, a loss is likely. Competition also drives down prices (read “gross margins”) to the “correct” level for each concept. If the automated car wash overcharges for a wash and wax to obtain a high gross margin, then one day a competitor will open a similar car wash that charges considerably less for the same service. To stay in business, the first operator has to cut prices to match the competitor. The only way either operator can then maintain a price differential is to offer special services, such as hand waxing.
Over time, consumer habits and competition create a natural level for pricing and margins that only differentiation can lift. In fact, one can draw a general rule that gross margins track differentiation. The more specialized the product, the higher the gross margins. The more a product approaches commoditization, the lower the gross margin, and the more that volume is required to compensate. Thus a new retailer has to carefully ask: Is my offering unique, or am I selling essentially the same thing as my high-volume competitor down the street? If the latter, how will I compete?
Broadly speaking, retailing falls into four financial groupings:
Food concepts, where gross margins often run 65 to 70 percent and sometimes as high as 73 percent, and where labor costs are high
Specialty retailing and targeted lifestyle retailing, where gross margins can be as high as 70 percent and almost all concepts are above 50 percent and labor costs are low
Traditional retailing, where gross margins have declined and now hover around 30 percent and where sales volumes and labor costs are moderate
Groceries and other high-volume businesses, where gross margins tend to be in the mid to high 20 percent range and where high labor costs result in low net margins (but high cash production)
Specialty and traditional retailing are more of a spectrum than separate groupings, with gross margins starting high for hand-made, one-of-a-kind items and declining as the products become mainstream. The following table, Table 10-1, of fiscal year-end results as of early 2004, shows the gross margins, corporate net income, and estimated store net income for a representative sampling of retail companies in different categories and at different degrees of differentiation. Most companies target corporate G&A at between 6 and 10 percent. However, the actual net income of individual stores is difficult to estimate across concepts because some companies and some industries are more efficient than others. In addition, some franchises hide corporate costs through additional mark-ups in the price of product and equipment to franchisees. Thus, corporate overhead can be as high as 12 percent. In Table 10-1 the corporate net income comes from company annual reports; the store net income is estimated from that number. For purposes of illustration only, corporate overhead is assumed to be 10 percent.
Table 10-1. Gross margins, Net Income, and Estimated Store Income for a Variety of Concepts
Company | Category | Gross Margins (Percent) | Corporate Net Income (Percent) | Estimated Store Net Income (Percent) |
|---|---|---|---|---|
Luxottica | Eyewear, accessories | 72 | 12 | 22 |
Starbucks | Food service | 65 | 13 | 23 |
McDonald's | Food service | 75 | 9 | 19 |
Chico's | Women's apparel | 61 | 13 | 23 |
Oakley | Performance wear | 56 | 7 | 17 |
Dillard's | Department store | 32 | 0.1 | 10.1 |
Whole Foods Market | Grocery | 34.5 | 3.5 | 13.5 |
Kroger | Grocery | 28 | 0.6 | 10.6 |
Safeway | Grocery | 30 | –0.5 | 9.5 |
Best Buy | Consumer electronics | 26 | 3 | 13 |
Gross margins and net income generally track the differentiation of the brand. Specialty or lifestyle brands have the highest margins, whereas less-differentiated brands have lower margins. For example (see Table 10-1), the gross margins of Whole Foods Market, which is highly differentiated, is higher than that for undifferentiated super markets Kroger and Safeway. The difference ultimately translates in net income that is three percent higher for Whole Foods—a huge disparity in a high-volume category. A corollary is that as any concept approaches a commodity, it becomes difficult for the retailer to maintain gross margins or net income, and the strategy must shift either to differentiation or to generating high volumes. Food service requires high gross margins to cover labor costs, so differentiation shows up in the net margins, where a high-quality brand will be in double digits and a quick-serve brand will be in single digits. The most important lesson for new retailers: You need double-digit net income from each store to produce an overall profit for a chain of any size.
Net store income, which equates to the profit contribution by each store unit, is the “end of story” for every concept. Some people say store net income of 10 to 12 percent for each store is pretty good. In my view, the “go” or “no go” number should be a net income of at least 12 to 15 percent for each store. I will not even look at a “four-wall contribution” (as store net income is also called) of less than 15 percent. For a growth concept, the number needs to be higher, 20 to 25 percent. Why take all the risk of opening a retail business and expend all the energy for years to make it succeed if you cannot get a 15 percent return for each store? Because you still have corporate overhead to deduct, leaving a final return of 10 percent or less, you are better off investing your money in something else—say for an 8 percent return and low risk. A low net income also makes it hard to support growth and cover the overhead of expansion.
From an entrepreneurial standpoint, store net income represents the fuel for growth. After you have a successful economic model, each store becomes a cash-generating machine. With net income of 15 percent, a store generating $1 million in revenue yields $150,000 in cash. Seven new stores generate another $1 million in net income. Become successful enough to open 100 stores a year, and net income increases by $15 million. At this point, you can hear the cash registers chiming all over the country. “Ka-ching, ka-ching—sending the money home.” In terms of cash to fund expansion, the net income generated by a concept is at least as important as the return on investment (ROI). A store returning 12 percent on $1 million in sales generates $120,000 in cash, whereas a store returning 15 percent on $600,000 in sales generates $90,000 in cash. The $30,000 may be the difference between being able to expand this year or next. For this reason, employees should receive incentives for the cash generated as well as for ROI. (Of course, you would also try to figure out why the smaller store is doing better on a percentage basis and try to replicate its success in the bigger store.) A few high-volume businesses such as grocery stores, drugstores, and gasoline service stations have net income in the range of 3 to 5 percent or lower, because fierce competition has suppressed pricing. However, high volume enables them to generate the necessary cash from the business. Kroger, the supermarket chain, returned only 0.6 percent corporate-wide net income for its most recent fiscal year, but that generated $314.6 million in cash, enough to build 30 more stores, assuming all the cash was used for this purpose. On a much lower base than Kroger, Whole Foods Market generated $137 million cash.
A healthy net income requires a solid financial model. The first step is the creation of the pro forma financial statement. This is not, as its name implies, “a formality,” but rather the best financial model you can create of the new business. The model, a typical U.S. financial framework, will work for any locale once variations in taxes and accounting methods are taken into consideration. Its main purpose is to enable an analysis of the business in detail, and in advance. The following overview assumes a working knowledge of accounting, which new retailers should have before proceeding too far with their concept. Business classes at local colleges can provide such expertise, and a search on “financial statements” at online bookstores will turn up a number of books on the topic. In particular, three good books in descending order of sophistication are Financial and Business Statements (2d Edition) by George Thomas Friedlob and Franklin James Plewa, which emphasizes daily operations, analysis of business details, and problem solving for people starting or managing a small- to medium-sized business; Balance Sheet Basics: Financial Management for Non-Financial Managers by Ronald C. Spurga; and Keeping the Books: Basic Record Keeping and Accounting for the Successful Small Business by Linda Pinson.
A look at the pro forma for a new retail store begins with a few assumptions. First, we will use $1 million as the estimate for annual sales. Many different kinds of retail outlets can generate this level of revenues, and $1 million makes a nice round number. In this example, COGS are 50 percent, which means that the gross margin is also 50 percent. From gross margin you subtract major operating expenses such as 10 percent for labor, 10 percent for advertising/marketing, and 8 to 12 percent for occupancy costs—all reasonable numbers for nonfood retailing. Subtracting controllable costs and general and administrative costs for the store leaves earnings before interest, taxes, depreciation, and amortization (EBIDTA, a standard metric in the United States). In this example, EBIDTA comes in close to 20 percent. From EBIDTA you subtract depreciation, which depends on the number of stores being built and their cost. In this example, depreciation is 5 percent, so net income turns out to be 15 percent—a very attractive store return.
The pro forma should include other numbers such as the revenue you need to break even. (Breakeven is the cost of COGS plus the cost of sales and G&A.) Most retail concepts also want to know the gross margin per square foot to determine the effective use of space. Food concepts, in which a large portion of space is set aside for consumption rather than sales, often track hourly transactions, the number of transactions per day, and the revenue per transaction. Starbucks tracks sales revenue versus rental cost to determine whether the real estate is returning a good value. Be sure to find out any other important metrics in your category.
Now you do a reality check against these numbers to determine their validity.
For a new concept, it can be difficult to come up with exact numbers. Even established businesses sometimes don't know what they don't know about their operations and costs. You can get detailed financial analyses of a company or industry from a stockbroker. You can purchase detailed industry trend analyses from market analysts who specialize in different fields. Dun & Bradstreet, Hoover's Online, and other services provide research on tens of thousands of businesses. Marketresearch.com provides in-depth research on industries and various retail categories. Bizminer.com provides research structured according to your use (marketing plan, business plan, business valuation, and so on) and has a special section for startups. Some reports are free. Most require a fee, and some of the fees can be hefty. Bizstats.com has a variety of detailed financial data on various retail categories. The Small Business Administration has a Web site with much useful information for start-ups and small firms. Scouring the Internet for articles on your industry will turn up interesting tidbits. Call a consultant who is an expert in your field. Some will provide a solid but fairly general analysis; the really good ones will provide a high level of detail. Organizations exist that provide coaching for start-up companies; identify someone with a strong background in retail finance. If you cannot afford a consultant, check with the local chamber of commerce. Many communities have retired business executives who provide business guidance to start-ups for little or no cost. SCORE, a nonprofit association, has both retired and working executives who provide entrepreneurs with free, confidential business counseling either face to face or via e-mail. You may also want to build an advisory board consisting of experienced retailers.
Perhaps the best place to begin is with annual reports of public companies in the same category. Pay special attention to “management's discussion and analysis” of company performance. Sometimes the analysis is perfunctory, there to meet minimum reporting standards, whereas at other times the analysis serves as an insightful “state of the industry” for that category. A review of Kroger's and Safeway's annual reports would tell you, among other things, that price pressures from supercenters and other discounters have substantially hurt gross margins of both chains. A would-be grocer would need either to factor in declining margins or to find a specialty niche insulated from the industry-wide price storms.
From these various sources, you begin to develop realistic numbers for your particular concept. You should be able to find the average sales volume per store. You can probably gauge the sales per square foot for your type of business, but you have to be careful. Staples has three formats and store sizes, and sales are not broken down by each one, for example. Kroger lists $53.8 billion in sales in 2,532 grocery stores and department stores, or $21.2 million per store. Revenue also includes convenience stores and fuel operations, so the big stores probably do $20 million annually. Store square footage is listed at 560 million square feet, which works out to a suspiciously low $98 per square foot, but Kroger's 42 manufacturing plants, plus distribution and office space, figure into the square footage, so you would investigate further to get average sales per square foot. One way would be to simply walk off the length and width of a typical store, compute the square footage, and divide that into $20 million. Whole Foods Market, on the other hand, lists its sales per square foot, $786, at the start of a recent annual report. Walgreens also proudly states that its drugstores average $7.4 million in annual sales and $677 in sales per square foot, so a drugstore concept has a ready comparison against the industry leader.
Further, major retailers, which are always looking for new locations, typically broadcast the size of stores they seek. You can check in retail trade magazines or talk to your real estate broker and quickly find what kinds of concepts are seeking what kinds of space. Claritas provides the number of employees and sales estimates of many companies so you can estimate the average revenue per employee. It is critical that you build the numbers from the ground up and benchmark yourself against competitors.
Sometimes the annual reports themselves have virtually all the information you need. Let's assume that you want to start a clothing concept that appeals to urban women older than 30, with moderate to high income. In its annual report, Chico's FAS, Inc., a chain selling to a comparable demographic, provided a chart showing that its net sales per net selling square foot were about $900. Separate figures showed that 426 company stores generated $738 million in revenue, or roughly $1.73 million per store. Divide $1.73 million in sales by $900 per square foot and you end up with stores that average a little more than 1,900 square feet of selling space, or probably a little over 2,000 square feet total space. Other charts and figures corroborate the estimates of per-store revenues and square footage in the low-2,000 range. The annual report of another women's apparel chain, Coldwater Creek, describes the two formats of its planned stores, 3,000 to 4,000 square feet and 5,000 to 6,000 square feet, as well as the expected sales per square foot, of $600 and $500 respectively. Multiplying revenue per square foot times store size, you end up with revenues of between $1.8 million and $2.4 million for the smaller format and $2.5 million to $3.0 million for the larger format. Taking the information from the companies together, you can make two important surmises. First, 2,000 square feet is probably a good workable size for high-quality women's apparel. Second, an established shop could generate as much as $1.7 million in sales in that format. Recognize, however, that it could take several years to reach that sales volume. Many chains use three years as a default assumption for a store meeting its full retail potential. Food concepts expect to reach full sales after 12 months.
Finding good numbers for high-end fashion concepts is more difficult because many of the leading companies are not public. You may have to pay for research on out-of-area markets, but you can use unobtrusive measures to establish how retail establishments in your area are doing during the different day parts and use this information to calculate total daily sales. For a restaurant, you can track approximate sales volume by pricing a typical meal and multiplying that number by the number of customers. In large retail stores, you can hang out by the cash registers to see what people normally buy and how much they spend in typical transactions. You can see what add-on purchases customers regularly select. In stores where loitering is not possible, you can guesstimate sales volume from the street by tallying the total traffic, the number and size of shopping bags people carry out of the stores, and the price of common merchandise. (It's not hard to tell that one shopping bag contains a pair of shoes and another has a couple of shirts or blouses.) Some retailers still track the daily number of transactions on their sales receipts. If you buy a couple of items from them a few hours apart, you probably will be able to calculate their numbers. Seek to estimate volume by the hour for all the major day parts along with the value of the average sales transaction. With public companies, you can use annual sales to estimate daily sales. More than 95 percent of all the data you need to construct a believable pro forma is available somewhere.
If a 15 percent return is the norm in your category and your projections show only a 12 percent return, it is imperative that you determine what costs must come down or what products (or product mixes) with higher margins are needed to increase revenue. You have to keep digging and refining your model until the numbers work. This approach will keep you disciplined—disciplined in getting to the right economic model and disciplined in your approach to site selection, another critical issue for revenue generation, as we will see.
Let's assume, then, that you have done your homework. You find that one similar concept averages more than $1 million per store. You find other data that shows that the category average is $500 revenue per square foot and that typical store size is 2,000 square feet. These figures reinforce your estimate of $1 million in sales. Glean every bit of relevant data and factor it in. Determine whether the norm is based on a five-, six-, or seven-day work week. Do you plan to be open the same number of hours per day as the companies on which you are basing the estimates? Some downtown locations have too little business to stay open on weekends, whereas others thrive. Which applies to your area? On $1 million in revenue, the difference between a seven-day week and a six-day week is roughly $140,000 in revenue annually—your hoped-for net profit! You would have to sell another $450 in merchandise a day to make up the difference.
As we saw with women's apparel, it is important to correlate your store size with the typical size for the industry. If the industry average income is $500 per square foot and the typical store size is 2,000 square feet, and you plan a 1,600-square-foot store, then your store must do $625 per square foot in sales to reach equivalent revenue. Depending on the number of days the store is open, this is a difference of $500 to $600 a day. If you are selling designer dresses, the differential may not be meaningful, perhaps one sale per day. But if you are selling $5 sandwiches, you would need 120 more sales per day. Is that volume reasonable? Could you physically serve the extra customers you would require (and remember they probably would come during rush periods)? Would there be sufficient parking? If you cannot increase the number of transactions, see whether you can change the product mix to increase the average price of each transaction. By increasing the average transaction by $1.25, from $5 to $6.25, the sandwich shop would make up the difference in daily sales for the smaller format.
After you have satisfactory figures for income, it should be relatively easy to match those numbers against associated expenses, which should be proportional to sales. Compare every line of your pro forma against whatever data you can unearth. Chico's gross margin in 2003 was 61 percent, and Coldwater Creek's was 39 percent. You would want to dig further to understand the discrepancy in cost of goods, which is also reflected in corporate net income of 13 and 2.4 percent, respectively. You would examine the results of other retailers in the category to ascertain conservative numbers that would most likely apply to you. (For simplicity, these examples show one or two comparisons, but you should do half a dozen or more. If you are in clothing, for example, you should be able to say about financials, “The Gap does this, Banana Republic does that.”) Selling and G&A expenses for Chico's and Coldwater Creek are similar, 37.6 percent and 35.1 percent respectively, so you could probably use 37 percent as a reasonable estimate for yourself.
Carefully review each of the line items involved in the cost of sales. Be sure to understand whether labor costs are high in your category, as is true for grocery stores and restaurants and similar service-related stores. In addition to price pressures, Kroger and Safeway faced increased health and pension costs that were also major factors in employee strikes in 2003 that further hurt the bottom line. Will you face similar expenses, or labor problems? Know whether your state has more restrictive laws on overtime, higher worker's compensation payments, or a higher minimum wage, all of which drive up labor costs. Most states require a minimum shift of four hours for each employee, which may increase the number of labor hours you need to plan for. Major shopping centers require stores to be open for fixed periods, something like 9:30 a.m. to 9:30 p.m. Monday through Saturday and 10:30 a.m. to 7 p.m. on Sunday, and levy fines for each hour you fail to be open. Your analysis must include the number of employees you will require for each day and each hour that you are open.
Occupancy costs can run 6 to 12 percent. Therefore, if you are certain that your other costs are in line, then you know that the 8 percent figure for occupancy costs in the above example is the maximum you can afford. If your occupancy costs are much lower, look carefully to see whether you have a location that will be good enough to support your sales projections. Maybe you are lucky and you have found a bargain, or maybe the rental price is telling you something about the ability of the space to deliver sales. Again, benchmark yourself against established retailers in the category. The others have been through the wars. They know what they can afford to pay to generate the foot traffic they need. If the occupancy costs are too high, either your income projections are too low or your proposed rent is too high. Use your calculations to negotiate with the landlord.
An exhaustive review of your projections against category averages and common sense should give you confidence that your projections are honest and defensible. The more each of your metrics lines up against established numbers from your category, the more likely it is that your overall projections are accurate. This same kind of analysis should be done regularly for existing stores to determine how to optimize operations. One of our clients had gross margins of 50 percent but the net income was quite low, and there were no obvious reasons. In our analysis, we discovered that the retailer had classed certain expenses as a manufacturer would rather than as a retailer. Once adjusted, the retailer's COGS were too high as a percentage of sales and gross margins were actually closer to 42 percent. Knowing this, we could analyze the COGS more closely. When further analysis showed that the COGS were in line, we could proceed to an analysis of other expenses. When these turned out to be within reason, then we could surmise that the real problem was that the stores needed to generate more revenue rather than just cut expenses. But until we could clear up the question of COGS, we could not successfully work through the rest of the problem.
Another aspect of analysis involves timing. Seasonality can make or break a store's ability to generate enough cash flow to survive in its early days. I have seen ski/snowboard shops open in July and close before the first snowfall. To last long enough for your financial projections to mean anything, you have to open your store as the category is coming out of the low season, taking out the worst two or three months of sales during your startup cycle. Whatever you do, open before the start of the high season to capture the best sales and establish the brand to help build momentum for the next year. Geography and weather determine much retail traffic. Resort areas have well-defined tourist seasons, sometimes two. In urban areas with cold winters, the summer is the high time for quick-serve and fast-casual restaurants and other retail concepts that benefit from “walking around” traffic. Mall concepts and white-tablecloth restaurants, on the other hand, show less seasonality. Both presume that people will be indoors. Spring and summer are the high season for automotive concepts. The more a concept depends on people being outside, the more the concept has to contend with seasonality. The high and low seasons are often obvious. The Christmas season is the high for soft goods and various gift products. Greeting cards sell well from Thanksgiving to Valentine's Day. Gardening equipment sells well in early spring. Chocolate eggs sell at Easter … And so on … At the national level you can check annual reports for comparable concepts to see which quarters have the lowest and highest sales. Using that data as a base, adjust for the seasonal patterns in your area that might apply.
Analysis of the pro formas of existing chains in my experience turns up three consistent problems:
Rent. Under the pressure to grow, it is hard to be a tough negotiator and keep occupancy costs down. Also, most concepts expand first to the bigger markets where competition and rents are highest. Plus, all chains, including the best, have a few nonperforming locations that fail to deliver revenue so the relative cost of rent to sales is high. In recent years the Gap closed 85 underperforming stores; Kroger had 74 underperforming stores and closed 44; and McDonald's closed about 650 stores.
Costs. It is tough for new concepts to duplicate their success when they get out of their home market. Most retailers need time under their belt to make their operational systems super-tight. As a result, labor as a percentage of sales increases. Also, money can always be saved in operational expenses, whether this is utility bills or excess use of copy machines.
Product mix. There is seldom a real model to attain a product mix that will generate the gross margins that are necessary for success. Most companies can quickly understand how to control costs but they do not always see the potential to generate more revenue by changing their mix of product lines. Retailers need to be aware of the uniqueness of each market and be very aware of the need to adjust product mix to meet local demands.
After you have put together an accurate pro forma, the numbers drive operational decisions. Depending on the detail, you can end up with 5 to 15 line items that serve as the metrics for each of your organizational teams. All the people in your company should understand your corporate goal for each line on the pro forma and their role in achieving those corporate financial objectives. If you are trying to achieve $667 per square feet in sales in a 1,500-square-foot store for $1,000,000 in revenue, and your pro forma shows that labor will cost 30 percent of revenue, then Bob, the head of operations, has to figure out how to hire and schedule staff over a year so that labor does not exceed $300,000. If occupancy costs are budgeted at 8 percent, then Anne, the head of real estate, needs to keep the total leasehold costs to $80,000 or less. If marketing is 5 percent, then John, the head of marketing, has to be effective with store advertising and promotions while spending no more than $50,000. It is usually easy to get senior people to sign up to accomplish their tasks; what is more important is to get them to achieve their results while staying within budget. Being over budget in each area by just a couple of percent can wipe out a store's profitability. Conversely, being under budget in several areas adds profit directly to the bottom line.