How to Build a Profit Margin
As an alternative to belt-tightening, you might consider spending more, smarter
Temps & Co.'s core business -- supplying temporary office help in the Baltimore-Washington, D.C., area -- was growing nicely each year, but it wasn't making any money. Annual sales hit $21.8 million in 1988, up from $20.5 million in 1987 and $12.8 million the year before. But every year, after salaries and expenses, practically nothing was left over. Steve Ettridge, founder and owner and a practical man, began to dream about creating a profit margin on these growing sales -- nothing extraordinary, maybe 5%. But where was that money going to come from?
The competitive market wouldn't permit price hikes, and cutting the wages that he offered temps would only make a difficult recruiting situation impossible. Also, Ettridge wasn't foolish enough to believe -- hope -- that just piling growth upon growth would somehow make his dream come true. No, if he was going to find 5% to bring to the bottom line, it had to be from T&C's operating expenses.
To most CEOs, cutting expenses means belt-tightening. But Ettridge resisted that impulse. Maybe, he thought, the answer isn't always to spend less, but to spend more and spend it smarter. How much you spend on any expense, he postulated, is probably only half the question. The other half, the half that slash-and-cut cost controllers often forget to ask, is what kind of return do you get for what you spend? Or, put another way, how much does it cost you not to spend money?
So with those questions in mind, Ettridge approached his cost-cutting challenge and got some counterintuitive answers. The particular facts and circumstances Ettridge found in his company, of course, won't exactly match your own. But his approach could help you get a better grip on your business's spending, with an eye toward increasing margin dollars.
* Stop running credit checks. "The quickest way I could think of to increase my margin," says Ettridge, "was to eliminate bad debt." Well, if he couldn't eliminate it, he could at least cut it back. No-pays were costing him as much as 2% of annual sales, or about $400,000. T&C was already doing routine credit checks on new accounts. Instinct would have suggested a redoubling of this effort. But Ettridge eliminated it.
Instead, Ettridge decided to "give" each new account $1,000 in credit automatically, figuring that if that's all he was stiffed by the occasional fly-by-night, he wouldn't lose much -- certainly less than it would cost to pore over the records of the majority of new customers who weren't going to cause problems.
He also had his computer begin tracking new accounts to see how quickly they began rolling up their debt. Those with no intention of paying tend to run it up fast, he says. The computer flags these, and the accounts-receivable staff can usually cut the loss at $2,000 or $2,500 -- half the average $5,000 hit the company had been taking.
Two things happened: expenses and bad-debt losses went down. T&C was able to cut two people from its five-and-a-half-person accounts-receivable department and slice 20 hours from the 60-hour workweek the rest put in. Bad debt declined to 0.5% of sales.
Then Ettridge tried one more idea. He started asking new customers over the phone for the names of two local credit references. The idea wasn't to call them. He just wanted to see how people answered the question. What he's found, he says, is that "the nice people pay their bills. People who get angry or huffy when we ask, they're the ones who don't." It's a quick, easy check, and in T&C's experience it works. The company's bad-debt losses are now running a measly 0.1% of sales.
* Pay people to sit around. In fact, don't just pay them to sit around -- give them free Cokes, juice, and coffee while they're sitting. In your business, this might be the equivalent of stocking more inventory, or keeping an extra work crew on duty.
The biggest cost of running Ettridge's business was the expense of recruiting new temps. T&C was spending more than $10,000 a month on newspaper ads -- $250 for every new temp hired. So if Ettridge could hire fewer temps and keep them longer, his recruiting costs -- advertising and screening -- would go down.
Ultimately, temps leave to take permanent jobs, but in the short run, they go because another agency gets to them with work earlier in the day. So Ettridge elected to bring most of the unassigned temps into a local T&C office every day at 9:00 a.m. and pay them to sit and sip until an assignment came through, which was usually by 10:00 or 10:30.
Paying people to wait, Ettridge estimates, costs the company $2,000 to $3,000 a week. But, he points out, you have to look, too, at the costs you avoid. At T&C, it has cut recruiting expenses. The company doesn't have to replace as many temps and, because it has first call on their time, it needs fewer temps in its pool to meet client demand. "Maybe it costs me $10 or $20 to have them come in and sit," says Ettridge. "It would cost me $250 to replace them."
And having a few extra people in the office ready to work the minute a client calls brings in additional profit dollars. If T&C can't fill a job because it doesn't have a temp available, it hasn't lost just one day's revenue. It's lost the $250-to-$300 profit it would have earned over the full length of the job -- which, on average, runs just short of two weeks.
Not only that, but the customer T&C can't serve will likely jump to the competition, and T&C must spend money to get the customer back or find a replacement. That costs . . . well, you get the idea. It's cheaper, Ettridge has learned, to spend a little to keep the employees and customers he's got than to incur the much larger expense of losing and replacing them and the profits they generate.
* Pay people more than the job is worth. This and the next bit of learning from the T&C experience are actually corollaries of the last proposition: spend a little to save a lot.
In the temps business, occasional mismatches of client's needs and temp's skills are inevitable. Say the client needs a $5-an-hour receptionist, and the only temp T&C has available is a skilled word processor expecting $10 an hour. Do you a) tell the client you don't have a temp to fill the job; b) tell the temp the only job available pays just $5 an hour; or c) charge the client for a receptionist and pay the temp his or her normal rate?
Ettridge picks option c. It costs the company roughly $40 out of pocket -- the $5-an-hour differential times eight hours. But is it really the most expensive option? Ettridge doesn't believe so.
With option a he stands to lose a customer, which costs more than $40 to replace. With option b he stands to lose the temp, who also costs more than $40 to replace. The cost to keep the temp and the customer happy is just $40. Besides, T&C makes sure the customer knows it's getting a deal for the day. "We'll invite them to try the receptionist out on some word processing," Ettridge says, and many times the client will ask the temp back to work at his or her normal rate. In a three- or four-day assignment, T&C can recoup in net margin its $40 investment in goodwill.
In another business, the same principle would suggest that you consider filling a customer's order with the more expensive product (or service) that you do have on hand, rather than making him or her wait for the cheaper one that you don't.
* Give away free service. Some days there will be temps left over -- people for whom no jobs turned up. Common sense says you cut your losses and send them home. At, say, $10 an hour, to keep them sitting would cost another $60. What a waste. But, on the other hand, what a resource.
"The best possible sales call I can make," says Ettridge, "is one of our temps." So, instead of sending the temp home (and letting him or her stop by to register with another agency on the way), a T&C salesman gives the temp to a potential client, a past client, or even a current client. "We say, 'We'd like you to try out one of our temps, free. Just take one for the day.' "
For a $60 expense, T&C doesn't lose a temp, impresses the hell out of a (potential) client, and cuts back on sales expense. "If you need a temp and we sent you a free one last week, who," asks Ettridge, "are you going to call?" Giving away the service, he's convinced, is the cheapest way to sell.
Would it pay for you to give some of your own service away?
* Hand out more cash. Next to finding temps, T&C's biggest challenge is finding people to staff its own growing offices. Here's where handing out cash -- in this case, $1,000 -- saves money.
T&C could do as most companies do and pay agency fees of $2,500 to $4,000 per person. Or it could pay its own employees much less to be talent scouts. Ettridge prefers the latter. Only he does it with a twist.
"We started out dumb," he says, "doing it like most companies do. We didn't hand over the money until the new hire had been on board for 30 days. Well, that tells employees that they have some responsibility to see that the new person works out. They don't, and that inhibited them. Their only responsibility is to give us the chance to make the right choice." So the staffer who recommends the new hire now collects his or her bounty immediately. The money expended on employment agencies and advertising has been cut practically to zero.
But more significantly, it's reduced expensive staff turnover from 25% or more annually to just 10%. Referrals now arrive much better informed about what's involved in the jobs they're seeking. "Most of them have gotten good scoop from the people already here. They know," says Crystal Ettridge, Steve's sister and company vice-president, "what they're getting into, and I never have to sell the job anymore."
Ettridge is still dreaming about that 5% pretax margin. Last year profits edged up, but they were still less than 1%. This year, with sales still climbing, he thinks the margin will climb to 2.8%. Now, if he can just come up with more things to spend money on, or a few more places to give it away. . . .