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Why Showroom Size And Content Is Critical To Profitability

Dec 16, 2016 9:14:09 PM

Contrary to popular opinion, a bigger showroom is NOT always better. At least, not if you want your firm to make a healthy profit. It might be good for your ego, for your sales staff’s use to make a good living, and for your vendors who love having so much of their product on display there. But a bigger showroom may not be good at all for your bottom line.

4 Key Ratios To Know And Monitor

To understand this apparent blasphemy, one must first understand the interaction of four crucial ratios that make up the Return on Investment Formula as shown in Graphic #1 below.

                                                      % Net Profit
                                                               X                    =    ROA
                                                             TAT                           X           =    ROI
                                                                                            FLM

                                                 Graphic #1: Return On Investment (ROI) Formula

Here are the definitions for these key ratios and some insights on how kitchen and bath dealers typically perform:

Ratio #1: Total Asset Turnover (TAT) says how well the assets are being controlled to get a better “inventory turn.” For kitchen and bath firms, that “inventory” is our displays. To determine your TAT, divide your Total Income on your Profit & Loss Statement by your Total Assets listed on your Balance Sheet. Four to six inventory turns can be accomplished in most industries. Unfortunately, kitchen and bath dealers typically achieve only 2-4 turns in a year. 

Ratio #2: Return On Assets (ROA) measures the profit earned from company assets which, of course, includes your showroom displays. Indeed, your displays should be listed under Current Assets on your Balance Sheet not to be depreciated. That’s because they are bought at such deep discounts the displays usually can be sold for a profit. As you can see from Graphic #1, your firm’s Net Profit % and TAT will determine the ROA. Most industries can achieve a 10-15% ROA where kitchen and bath dealers are lucky to record a 6-8% ROA.

Ratio #3: Financial Leverage Multiplier (FLM) measures the strategic use of other people’s money compared to the use of company funds to acquire assets. To find your firm’s FLM divide the Total Assets shown on your Balance Sheet by the Net Worth. The desirable standard that bankers look for is 2.0. Because kitchen and bath dealers can command terms of 50% upon signing, 40% upon cabinet delivery, and 10% upon substantial completion, this is one area where they shine. In other words, dealers can use their positive cash flow from client deposits to buy displays, trucks, etc. As a result, it is not unusual for industry dealers to post FLMs of 4.0-6.0.

Ratio #4: Return On Investment (ROI) measures a company’s rate of return by bankers, accountants, and investors versus other investment options. Multiplying the ROA times the FLM produces the firm’s ROI as shown in Graphic #1. The goal of most companies, regardless of what industry they are in, is to achieve a 15-20% annual return on investment. The range for kitchen and bath dealers is all over the lot - from a negative ROI percentage to over 100%.

Recommended Showroom Size To Boost ROI

From this financial analysis, it should be clear that kitchen and bath dealers must focus on substantially improving their Return On Assets (ROA) to increase their Return On Investment (ROI). And that is why, in my judgment, showroom creation must be marketing and financially driven, not design and ego driven. 

So what would be the optimum showroom size in most market areas for a kitchen and bath dealer who serves as the firm’s chief Sales Designer? I would recommend budgeting for a relatively small, but effective showroom/office space of approximately 1500-1800 square feet that has the potential to enhance a dealer’s Return on Assets (ROA) two ways:

1.    Earn A Greater Net Profit %. Cutting the square footage from the 2-3,000 square feet I often see will lower the rent expense. And rent is usually the third largest dealer expense after cost of goods sold and personnel. A smaller showroom also effectively lowers utility and maintenance costs as well as any possible common charges.
2.    Achieve A Greater TAT. By cutting the number, size, and cost of showroom displays, the asset investment is reduced. The proper marketing of your services in your showroom, together with an effective media and public relations plan, can produce even a greater income than what a larger showroom with more displays might. 

Indeed, most dealers over invest in their showrooms and under invest in the requisite marketing that would enable their operations to reach a higher level of profit potential. These dealers often rely too much on word-of-mouth advertising and get hurt financially when a recession settles in.

Recommended Positioning Of Showroom

In my opinion, a showroom should be an educational center. Yes, you want to sell kitchens and baths. But the educated consumer of today is looking for ideas and information. After all, kitchens and bathrooms are the most complex rooms to design and the most costly rooms to build. 

So put their needs ahead of your needs and you will get what you want. Give them the information they need to feel comfortable in choosing your firm to do their project. Install a "storyboard” to visually explain the entire design and installation process. (See page 46 in the May issue for more details). Install a “Cabinet Comparison Display” to have them understand the construction - and hence the cost – differences between the cabinet lines your offer. Have an Information Center prominently located and filled with booklets entitled How To Buy A Kitchen, How To Buy Cabinetry, How To Buy A Bathroom, and Relax During Remodeling. 

Take these steps - in showroom size and content - and you are very likely to have your firm generate over $1,000 of annual income per square foot with gross margins well in excess of the industry average of 35-36%. Take these steps and you will see your Net Profit %, TAT, ROA, and, most importantly, your ROI results improve dramatically. 

Ken Peterson, CKD

Written by Ken Peterson, CKD