In the early 1990s, Tom Chatham figured his company was riding high. Early success with the Service Merchandise catalog showroom and retail chain was bringing in as much as $1 million in sales to his company, Chatham Created Gems in San Francisco. Better still, the company’s work for Service Merchandise had attracted business from other retail players. But something was bothering Chatham.
“We were going crazy with keeping up, and all the while I noticed we were not making any profit,” he recalls. To get all that mass-market business, Chatham had to offer prices near cost and also pitch in on advertising, displays, and brochures. When a round of price wars took off in 1995, squeezing even more out of the equation, he drew the line.
“Since the late ’90s I made a decision to stop selling any of these ‘squeezers’ that take your life’s blood until you die, then toss you aside. Our bottom line has never been better and life is a lot less hectic,” he says. The company’s customers now are primarily independent retailers, although Chatham sells directly to individual stores of the major chains on a store-by-store basis.
The choice wasn’t easy. One by one, major accounts headed straight for his rivals when he refused to meet price demands. Nevertheless, the strategy paid off. Some competitors went broke trying to undercut each other’s prices. And some buyers complained that they weren’t getting the same quality from their new suppliers that they had relied on from Chatham.
Chatham Created Gems had learned an invaluable lesson: Before you jump for the golden ring of big orders, take a good, hard look at your business model and make sure your company can handle everything involved in serving that customer – from tight margins and shipping schedules to required inventory levels and payment terms – and still make an acceptable profit over the long term.
“Sales do not equal profit,” says Cindy Edelstein, president of Jeweler’s Resource Bureau. “It is incredibly easy to not make any money.”
With retailers pushing for lower prices, and companies overseas more than willing to cooperate, it’s not easy to stand one’s ground, especially if mouth-watering sales are at stake. But breaking a deal down into its crucial components, whether it’s the sales price or conditions on returns, can help create a clear picture of whether the deal is really in your best interests.
Before accepting a job, evaluate it thoroughly by asking yourself the following questions:
In today’s price-point-driven market, companies are often tempted to cut prices drastically to secure a new, large customer. In many cases, the long-term effects are detrimental to not just the individual supplier but to the entire industry: Companies race to the bottom both in terms of profits and quality, pushing many out of business, Chatham says.
“That’s the mentality of our industry. ‘The customer will never pay more,'” he says. “Go tell that to Hearts on Fire or Rolex Watch or David Yurman,” whose brand names command a premium among consumers.
The same pragmatism should apply to payment terms. Can you afford to wait 60 days, or even 30, to be paid? “Extended payment terms only prolong the problem-credit sales are, in essence, small loans to our customers,” at no interest, no less, says Eric Carstensen, a professor at the GIA School of Business in Carlsbad, California. “A business that is already cash poor is really not in a position to be lending money.”
A large chain may start with items in a few stores but quickly ramp that up, taxing production resources. To keep up with orders, you might have to carry higher inventory levels, which poses a risk if customers change their minds. Even orders that come in reliably may require additional investments in facilities, workforce, and equipment. If it’s a hit, can you keep up with a customer’s increasing demands and still maintain an acceptable profit margin?
Michael Good Designs faced a crossroads in the mid-to-late 1980s when the company hit about $1.5 million in sales, says Avi Good, general manager of the Rockport, Maine-based company. They could have developed major production operations, but the company instead chose to scale back to a smaller level, even if it meant turning down some large orders.
The choice was based as much on the desire to maintain the small business feel of the company as on concern that serving larger customers would mean dealing with more rules and pressure from customers, she says. “Making the choice to stay with smaller businesses gives you the luxury and freedom to deal with your customer on a one-to-one basis.”
Designer Alex Sepkus’s New York City-based company often finds itself telling customers “no” in December, as holiday season orders peak, to make sure it doesn’t overwhelm its roughly two-dozen jewelers. “It’s frustrating, because you have to leave a lot [of business] on the shelf,” says Managing Partner Jeff Feero.
One of Michael Good Designs’ mottos is “don’t take an order you can’t afford to lose.” That’s also something to consider when selling to television sales channels, where today’s trendy must-have could be tomorrow’s old news.
A company should evaluate every aspect of a customer’s policies, such as packaging, inventory, and delivery requirements, restocking privileges and return times, as well as possible fines for non-compliant shipments. Keep track of how often a customer uses, or abuses, these penalties.
Michael Good Designs eventually decided to discontinue sales to department stores because of frequent returns. “There were times when we ran into the brick wall of getting a package back in the mail containing a quarter of a really large order,” says Good. “When you’re a small company and you do everything to order, returns aren’t really part of the equation.”
“It’s easy to say, X customer is doing a million dollars. We need to service them no matter what,” says Torry Hoover, president of Richmond, Virginia-based Hoover & Strong. That is, until you factor in lower margins, longer payment terms, the $15,000 in returns a year and the extra polish the customer may require. “You may have a half-a-million dollar customer that you’re earning 20 percent on that is paying in 30 days, that never returns an order, has no special demands and really is under the radar because they order weekly and everything runs smoothly.”
Some companies also say they prefer not to sell directly to their customers’ customers, even though the resulting orders could be lucrative, because that would harm long-standing relationships with current buyers.
As with any relationship, there may be requests for favors. If these become burdensome but are also a quid pro quo of doing business with a company, it might be time to step away.
Think twice about doing repeated “favors,” even for long-time
customers, if past experiences have been less than optimal, advises
Edelstein. In one case she recalled, a jeweler received an emergency request from a customer for 10 pairs of gold cufflinks to show to an interested buyer. The supplier agreed, asking that they be returned in time for an upcoming trunk show, then dropped everything else to stay late, package the cufflinks attractively in custom boxes, and ship them overnight. The “favor” cost more than $600.
Two weeks later (well past the trunk show), the supplier received the cufflinks back, with not one being sold, and without the boxes. The real surprise, Edelstein added, was when the supplier commented, “I can’t believe they did that to me again,” explaining it was the third such incident.
The best way to get a heads up on which of these issues you might face is to diligently contact the other suppliers provided by your prospective customer as references. Ask about the smallest details that might tip the balance one way or the other, advises Good.
The more thought you’ve put into these issues before you actually face them, the better prepared you should be to evaluate how potential risks of an order stack up against the benefits. If the risks seem too high, you need to be upfront and steadfast in conveying your concerns to the customer.
Set a policy that lays out what type of payment terms and other conditions you can work with. For example, can you afford to stretch terms to 60 days? Will you accept returns after six months or a year, and will you require permission before they can send a shipment back? Be consistent and upfront. If you’re clear on what you’re willing to offer from the start, it’s up to the customer to decide whether they can work within that framework, says Good.
Hoover & Strong requires payment in 30 days from all but a handful of customers, Hoover says. If they’re particularly concerned about a company’s ability to pay, they’ll ask for prepayment. Alex Sepkus won’t go past 60 days, period, Feero says. And Michael Good requires prepayment on all first orders.
Simply noting a company’s response to your guidelines can be a good way to evaluate future potential. A customer unwilling to commit to prepayment on a first order might be a risky bet, Good says.
Are you willing to agree to an order immediately? Will the buyer give you time to crunch the numbers? If you have any doubt about whether you can handle an order, don’t feel pressured to agree on the spot, such as at a trade show or customer visit, says consultant Bruce Baker of Middlebury, Vermont. Phrases like “Let me do a little figuring” go a long way, he advises.
If the terms of an order won’t fit your business model, say so. “Everybody understands that you’re in business to add to the profitability of the customer. Most customers should understand that you’re in it to make money also,” Hoover says.
Baker suggests his clients “be assertive, not aggressive,” and avoid using the word “no” as much as possible. “If I say ‘no,’ the counter is ‘Well, why not?'” he says. “If I say, ‘It’s not possible because,’ then they see some reason.”
Sometimes you’ll need to say no not to a new client, but to a customer with whom you have an existing relationship when that customer has abused your good will. Alex Sepkus no longer sells to one luxury chain after getting burned while trying to help out an eager store manager. The manager wanted the order shipped directly to the store, in contradiction of the chain’s policy. Sepkus relented, having been assured permission was granted in this instance, only to be hit with a chargeback anyway, says Feero.
Chatham had a very brief relationship in the mid-1990s with retail giant Wal-Mart Stores Inc., which agreed to sell some 15 styles of his emerald and ruby collection in about 3,000 stores. When he went to check out some of the stores, he found less expensive copies sitting alongside his work-all in his branded displays. They were being sold for half the price of his own pieces. He demanded the company sell off his products and remove his name from the display within a quarter, which it did. He was “fired” as a supplier for complaining, only to be approached by a new Wal-Mart buyer about 10 years later, he says. Unable to secure a guarantee that he wouldn’t face the same situation, he turned them down. (Wal-Mart was not able to confirm or comment on the account by press time.)
But cutting off buyers who aren’t meeting their obligations doesn’t always mean you’ve lost them forever. Almost 10 years ago, Alex Sepkus “fired” two accounts, whose annual sales were about $45,000 and $68,000, respectively, because they fell behind, pushing payment past 90 days in some cases. “I just waited until they zeroed out, and then said, ‘Good-bye,'” Feero recalls.
The companies initially were “dumbfounded and shocked,” he says. Within a few months, however, they returned, and the jewelry maker demanded prepayment for future shipments. The customers agreed – and now rank among the company’s top 10 accounts.
In the end, saying “no” may actually be a positive move, as it was for Alex Sepkus. A “no” to a large order that is of dubious financial benefit can be a “yes” to profitability, if it’s a well-informed decision made with a company’s long-term interests in mind.
Most companies agree that there is no single equation into which you can plug prices and terms and come out with a “yes” or “no” answer. Each order must be evaluated on its own merits: Will future increases in sales to this customer help leverage the costs? Does this customer bring additional prestige or storefront numbers that will reap rewards down the line? Can you meet the labor demand with your existing workforce without jeopardizing your ability to fill other orders?
“There’s always risk,” says Avi Good, general manager at Michael Good Designs. “For a small company that’s getting going, you have to risk some of the issues because you want to grow.”
The following are some elements to consider when analyzing a potential order:
If your customer is demanding a lower price, to what extent will that fall down to the bottom line? Calculate the contribution margin, or the difference between the selling price and the variable costs (including materials and labor) to make that item, says Eric Carstensen, a professor at the GIA School of Business.
Suppose you have an order for 6,000 units and your usual selling price is $50 per unit. With variable costs of $195,000 the contribution margin is $105,000, or $17.50 per unit. If you have fixed costs of $75,000, your operating income will stand at $30,000.
When your customer squeezes the price to $47.50, the contribution margin falls to $15 per item, and your operating income is sliced in half to $15,000, Carstensen points out. That might be an acceptable risk – until the customer decides to trim back the next order to 5,000 units. Contribution margin remains $15 per item, but your operating income line is now just treading water at break-even. “Including the per unit variable costs associated with returns of units, restocking of returned units, etc., we’d see an even bigger disappointment,” Carstensen says.
Discounted Price point at Original Volume
|Sales (6,000 units)||285,000||47.50|
|less: Variable Expenses||195,000||32.50|
|less: Fixed Expenses||75,000|
After Decreased Volume
|Sales (5,000 units)||237,500||47.50|
|less: Variable Expenses||162,500||32.50|
|less: Fixed Expenses||75,000|
(Source: GIA School of Business)
“Don’t pay for last year’s manufacturing with this year’s growth,” Cindy Edelstein, president of Jeweler’s Resource Bureau, warns.
Even if an order is profitable on the surface, increases in inventory, receivables and fixed asset costs related to the customer, as well as loan repayments, can lead to negative cash flow. “If we have sufficient cash coming from other areas of the business, this may not be a problem. If this is our biggest account, we would be in trouble,” Carstensen says.
Don’t be caught off guard when a customer rejects a shipment, or levies a fine, because you put the shipping label in the wrong place. Make sure you know your customer’s position on the following: Do they require special packaging? Will they ask permission before sending back rejected items? How will they package returned items? Will they return the item, or levy a charge-back?
Any business relationship needs some give and take. In some cases, you might be able to negotiate a “No” into a “Yes, but” situation.
Let your potential customer know you’re willing to work with them to the extent you can. “Sometimes that means saying no, but we have options a, b and c that we’d like to pursue,” advises Rick Bakosh, managing partner of sales strategy and sales transformation at Accenture, a New York-based consulting company.
Similarly, if you’d like to accommodate a customer but some terms aren’t acceptable, see if you can negotiate concessions that balance some of the risk, Bakosh says. Your customer wants a bigger discount? Ask if they’ll accept shorter payment terms.
“We will go overboard to service a customer,” perhaps by stopping production, speeding up delivery or offering a customized touch, says Torry Hoover, president of Hoover & Strong. “All we ask in return is pay in 30 days.” And don’t return the product, he adds.
If size or speed is a stumbling block, try working with another company to accomplish the task. In one instance, Hoover & Strong was approached by another manufacturer looking to produce a million diamond chip earrings for a customer for a special promotion – with delivery in 60 days. Just getting the gold and other materials for the cup settings and diamond chips would have left about two weeks for the assembly process, says Hoover.
Instead of turning the order down, Hoover & Strong worked out an agreement to share capacity with the manufacturer that had approached them, after making it clear that it would take 90 days.