The Middle Line: Key to Profitable Growth

Everyone knows that the “top line” refers to revenue, and the “bottom line” is profit. This comes directly from their position on a Profit and Loss statement. But what is “the middle line”? It’s right there on the same page labeled gross profit or gross margin. Technically it’s the difference between Revenue and Cost of Goods Sold–but there’s a lot more to it than that. And it’s a key to profitable growth for any company.

Growing the Middle Line

Let’s take a company with revenues of $1 Million, a 30% gross profit margin, and a 10% operating profit. This company is comparing two growth initiatives: grow revenues by 10% or increase gross profit margin by 5%. Which alternative has the bigger impact on the “bottom line”?

 

	Base	Rev + 10%	GM + 5%	Rev + 10%, GM + 5%
Revenue	$1,000	$1,100	$1,000	$1,100
Gross Profit	$300	$330	$350	$385
Operating Profit	$100	$130	$150	$185

 

If the new revenue initiative brings in another $100K–with no increase in costs–it brings an incremental $30K to the bottom line. Compare that to increasing the gross profit margin by 5% and bringing an incremental $50K of operating profit. Doing both at the same time brings in an incremental $85K, increasing the company’s operating profit margin from 10% to 17%!

This example shows the strategic value of the “middle line” to the organization. So where do you start?

There is no one-size-fits-all solution. Gross profit will vary across industries, regions, and sectors. Within a given market it is a indicator of the value you bring to customers relative to competitors, and your efficiency in delivering it. That’s why it’s such a powerful measurement.

Let’s look at both strategic and tactical implications and discuss ways to grow your own “middle line”.

Strategic Review

Chances are you make a range of products and product families. Most manufacturers have grown their product portfolio over many years. Your gross profit is the sum of all these individual products sold to all your customers. Profitability will vary across your products and across your customers.

When was the last time you reviewed profits by product and customer? If you have to think about it, it’s probably been too long.

Before you can do the analysis you need to have the data…the right data. How accurate are the product costs you use? Do they include actual materials, labor, energy and other utilities consumed or are they allocated average values? Getting the right baseline information is critical.

Fix the Mix: Products and Customers

A portfolio review should be done with the executive team, including sales, marketing and operations. Chances are you will be able group the products into three bins: high, medium and low margin. Then the fun begins. Which are growing and why? Can you eliminate some of the low margin products? Can you buy them from someone else? What can you do to improve the margin on other products? Small actions on individual products can add up to big gains in your total gross profit picture.

That brings up the other half of the equation–customer profitability. Some customers are more costly to serve, either because of additional complexity or lower prices they are willing to pay. It also varies based on which products they buy. The result is that some customers are more profitable than others.

In reality, you need to take both the “product view” and “customer view” into account when making decisions. You may have a very profitable customer that also buys some low volume, low margin products. The low profit products may be an important part of the relationship. You will only find the right answers by working together as a team. Dealing with these strategic issues takes time, but brings ongoing benefits.

Stop the leaks

There are steps you can take immediately to grow your middle line. One place to start is finding “revenue leaks.” These are the small, often hidden deductions that are considered part of the cost of doing business…business as usual that is. Let’s review some potential areas where these leaks can occur.

Your end customer pays a certain amount for your products. Do you sell directly or are there brokers, agents, distributors or reps in between? What are the associated fees and expenses involved? If you deal with retail, are there slotting fees or promotional expenses involved? Do you ship your product to the customer? How often does product get returned to you?  You quickly realize the dollars your customer pays gets smaller before it gets on your books.

How is discounting handled? Companies often have different levels of discounting allowed for sales personnel, managers, and executives. There may be a discount sales can take without approval to increase the chances of getting the order. Or has it developed into a “standard” discount? Make sure you are getting fair value for your products.

Another hidden form of discounting is giving something away–special shipping requests for example. You turn around that emergency order and build on your relationship with that customer–but would they be willing to pay extra for that service? What about that special labeling or custom feature–are your prices being compared to a plain vanilla solution?

Some of these “leaks” can be plugged pretty easily. You can change a policy about emergency shipping costs. You can raise prices on a product with perennial discounting.  It all adds up quickly, and again, these improvements drop straight to the bottom line.

Taking it from here

The “middle line” is key to profitable growth in both the short term and long term. A strategic review of your product and customer portfolio can increase gross profit and help guide decisions on where to invest.  There are immediate gains from operational changes in shipping, discounting and selling practices. Get help from others if needed. Just don’t miss the opportunity to grow the “middle line.”