A recent study (Plastics Today; June 27, 2011) indicates processors are happy with an 8% return on sales (gross profit margin) because the historical average is 5% to 7%. If you're happy with 8% and you expect the market to give you that, then there's no reason to change your approach with respect to profit margins. You are content with the status quo and comfortable with the future. Read no more.
If, however, you don't think the market owes you a profit and you're uncertain about the future, keep reading. This is a first in a series on a proactive and proven approach for processors to manage profit margins - and it works for small-to medium-sized companies as well as larger concerns. With this approach, utilizing the new resins pricing paradigm, you can:
- Capture higher profit margins - consistently, and months ahead
- Secure customers and your future
- Beat your competition, handily
First, consider this as applicable for all processors:
1) Gross Profit Margin (GPM) = Sales - Total Operating Cost
Total Operating Cost, TOC = (Resins + Manufacturing) Cost
Assuming resins are 50% of TOC, TOC = 2 x Resins Cost
2) GPM ($/lb) = Product price per pound - (2 x Resins price)
3) 1 + (% GPM ÷ 100) = Product price per pound / (2 x Resins price)
For a 20% GPM --
4) 1.2 = Product price per pound / (2 x Resins price)
For Poly Wise, our fictional polypropylene processor who wants higher margins and a secure future:
1 + (% GPM ÷ 100) = Product price per pound / (2 x Polypropylene price)
For a 20% GPM --
1.2 = Product price per pound / (2 x Polypropylene price)
If polypropylene is $0.83/lb, 1.2 = Product price / (2 x 0.83)
à Product price for 20% GPM = $2 per lb
Feeling the heat
Poly Wise works closely with its customers and knows they're under a lot of competitive and margin pressure. 2012 looks grim and customers tell Poly Wise their budgets leave no room for price increases in Poly Wise's products. They ask Poly Wise (and Poly Wise's competitors) for help in meeting or beating their budgets so they can be profitable and stay in business next year. Poly Wise's production is already less than 40% capacity and it feels the heat.
The challenge and the problem
Poly Wise asks customers what 2012 prices they would like from Poly Wise. The company learns that $1.70/lb would enable most customers to beat their budgets and secure business in 2012. Unfortunately, at $0.83/lb for polypropylene and a product price of $1.70/lb, Poly Wise's GPM is less than 3%. Polypropylene would need to decrease to $0.77/lb for Poly Wise to have a 10% GPM. Further complicating matters, Poly Wise has neither the capital nor storage needed for a long-term, fixed price purchase of polypropylene - assuming it could even find a willing supplier at a reasonable price, let alone a price below the short-term $0.83/lb. Suppliers are feeling the heat as much as processors. Poly Wise searches for a solution and finds ...
A way out and up
After reading about the new resins pricing paradigm on Plastics Today, Poly Wise sees a way to help its customers and itself. A supply of polypropylene at a price spread to crude oil will position Poly Wise to make customers happy and increase profit margins while even enabling its suppliers to do the same. Poly Wise contacts polypropylene suppliers, hoping to find one as 'wise' as it is.
To be continued ...
About the author: Tom Langan is a risk management and trading consultant dba WTL Trading. He provides two levels of risk management services to processors and suppliers to help control resins costs, secure and improve profit margins, and increase sales.