Correcting the Rule of Thumb

Oliver Norman in System September 1 1907

Correcting the Rule of Thumb

Oliver Norman in System September 1 1907

Correcting the Rule of Thumb

By Oliver Norman in System

THE board of directors’ yearly communication lay before the general manager of the Mann Mercantile Company.

It was his first news of the proceedings of the annual meeting. For Johnston was not a member of the board of directors ; in fact, no one really was—except Benjamin Mann, founder, ninety-nine per cent, owner, eleven-months-of-the-year-absentee president of the Mann Mercantile Company.

So this polite and ambiguous letter to the general manager, expressing the directors’ appreciation of his personal faithfulness, but also their disappointment in the year’s meager profits and their hope that the coming year would show increased results—this was really a direct message from Benjamin Mann to Oliver Johnston to the effect: “Show a bigger profit in the next twelve months—or your resignation.” Johnston’s call button rasped. A word to the answering messenger boy brought in the treasurer—built on the order of Mann’s directors—a glorified cashier and head book-keeper.

The general manager went right to the point. “Braun,” he said, “you and I are the only men outside the directors who know that this institution made less money this year than last, on a twenty per cent, greater volume. We were surprised, puzzled. Our one-man directorate is more than surprised. And it is up to me to find the cause and remedy it. My hunt begins to-day—the tenth of January— I want no further time handicap, for I have got to find the goal and make the run by December 31. Have you any idea as to the source of the trouble ?”

“I am checkmated on this question,” the treasurer replied. “You have our figures ; sales nearly onefourth more than last year—gross profits as large in proportion—all departments showing the necessary percent-

age of profits on the books; yet expenditures went way up and more than absorbed the additional gross profits.”

“If you can’t tell me, no one in this house can,” Johnston said. Then, decisively—“I will know. To-morrow a new clerk comes into the executive department. Tell him everything, give him anything he wants, open up our books to him. He’ll have to be the Stanley of my Livingstone in the Africa of the Mann Mercantile Company.”

So on the morning of January 11, I entered the employ of the Mann Mercantile Company as general clerk.

It was a progressive store I began to study—full of the hustle and ambition of young men,,, and yet well directed by the merchandizing ability of its manager. The books showed the situation: an increase in volume of sales ; corresponding increase in gross profits, for the margin between costs and selling price remained the same; the expense list had taken an unwarranted increase.

It was on the expenditures that I therefore concentrated my attention.

“The first data I want to get from your books, Mr. Braun,” I said to the treasurer, “are the items of expense for last year and this year.”

“We can give you those in an hour,” Mr. Braun answered.

The two sets of figures came to me, item by item—rent, light, heat, labor, equipment, repairs, delivery expense, supplies—all the expense accounts.

They brought out nothing startling, or even significant; the percentage of increase was uniform over all. No one item, as I had hoped, showed a comparatively greater rise, thus marking it for special attention.

“Either some adverse general condition or some broadly mistaken policy of management,” I reported to Braun at the end of a day’s scrutiny of the figures, “has caused this pro-

portionately large increase in expenditure, or there is some one part or another of your store responsible for the increased expense in all lines. The next point, therefore, is to find what the increase in expenses has been by departments.”

“But my books won’t show that,” the treasurer answered. “This is not a department store, you know, although we sell different varieties of goods. All expenses are figured in totals and charged to the store as a whole.”

“But you surely have distributed your expense,” I protested, “so that you know how much labor, how much rent, how much delivery expense, how much of any general expense, is to be charged to each general merchandise division of your business ?”

“Nothing of the kind,” the treasurer answered. “In the old days Mr. Mann, and now the present manager, have had complete and direct charge of the business ; the figures of sales, which are kept by lines, and the general expense totals enable them to know the condition of the business.”

The statement was made with such assurance that I was nettled.

“Why is this investigation going on,” I demanded, “if these figures show the condition of the business ? It’s because your manager does not know the store’s condition that we are making this analysis. What’s the use, for instance,” I added, “of knowing the increase in sales by lines when you don’t know whether the expense of selling those lines is increasing proportionately ?”

The treasurer made no reply.

“Let me see,” I asked, “the report of sales by lines for last year and also for the preceding year.”

Here I struck something. Not a clew exactly, but at least something different. There was a general increase in the volume of all lines, but five lines had increased very much more than the others. I looked up the location of these lines in the store, the stock carried of each, the gross profit they showed. At the end of

the day I dropped into the general manager’s office.

“Have you started any new departments this year, Mr. Johnston?” I asked, casually.

“Yes,” he answered. “Three—although no one of them is extensive. We opened a music-box and phonograph department just before the holidays of last year. Then in the spring we introduced a line of sheet music, and as the goods seemed to be akin we put in books a little later.”

“And are there any lines of goods that you pushed harder last year than you did before?”

“You bet we did.” And the salesman’s spirit within him kindled his eyes. “We certainly cleaned this town up on library desks and display counters. Times are prosperous; there have been a great many developments in this line of goods lately. Everybody seems to be putting in new equipment, and I was bound that we would get what was coming to us. I happen to know we got a good deal more. We did nearly half the business that was done in this town in these lines.”

Then, as if recollecting that I would probably not be interested in the little gossip of the store, he added, “How are things going ; any news ?”

“No, not yet,” as I arose and swung the door. “I won’t have anything to say until I have something worth while to report.”

The next morning we set two clerks from the accounting department on what turned out to be a long job—the distribution of all expenses by departments or lines of goods. It was not only a long task, but a very difficult one. It meant going over every item of expense, every payroll and invoice, charging the wages of the clerks to the goods they sold, charging each department its proportion of the rent, heat, and light according to the space it occupied, going through the delivery slips and charging each department according to the time that had been spent in the delivery of its goods. And even harder was the distribution of the general expense—the superin-

tendence, the janitor work, the accounting and administration expense.

It was two weeks before I had all my detailed figures ready for assembling ; and when I began this final stage of the work I felt like an engineer must feel when the next blow of the pick is to join the two ends of his tunnel, according as he has calculated them in his blue-prints. Here I must find the trouble point—or I could find none, for my study of the business showed no other opening in the apparently strong front of the management.

It was the next morning that I went in to see Johnston with two sheets of paper in my hand.

“I have something to report,” I said significantly. And although it was his busy hour, he cleared his desk and his office.

“Have you ever thought, Mr. Johnston,” I began, “of exactly how much it costs to sell a sheet of music, or a chair, or desk, or piano ?”

“I know the percentage,” he came back quickly. “My monthly reports give me that.”

“But I mean in a more detailed fashion than that. Have you any idea how much clerk hire it costs to sell a chair—how much rent, how much wear and tear on equipment, on your door springs even, in that one sale— how much of your superintendent’s and your floorwalker’s and your door opener’s time it takes to handle that one customer? How much it costs to enter and post the bill and collect the account on that one chair? How much it costs you to deliver the goods ?”

“It’s all in the percentage,” Johnston repeated. But his answer was not so cock-sure as it had been before.

“I can tell you,” I said, “how much it costs you in rent and light, and heat and clerk hire, in superintendence, in wear and tear, accounting and administration to sell, if not one chair, at least all the chairs you sold ; or all the pianos you sold, or music boxes, or desks, or books. That is more than you ever knew before, isn’t it?”

“Yes,” he said, “more than I cared

to know, because it is only itemizing, it is only dividing up the entire expense. As long as I know the percentage, I know where we are at.”

“But you don’t know the percentage. You know, for instance, that your profit last year was four per cent, on all the goods you sold, taken in lump.”

“Yes,” was the answer.

“You have not known until this moment that while you made four per cent, on your chairs, you made six per cent, on your rugs and carpets, only one per cent, on your books, and that you lost money on the sheet music you sold, and on the musical appliances, and on the library desks, and barely played even on the counter line?”

The general manager had the right hand drawer of his desk open before my statement was finished.

“That’s impossible,” he asserted, as his hand placed the last report on his desk. “On musical appliances, for instance, we made a gross profit of fifteen per cent, and our operating expenses are only ten per cent., so we made five per cent, there. On our sheet music we made a little less, I confess. The gross margin there is only fourteen per cent., but even there we made fully four per cent.”

I laid my sheets down on his desk. There was a department for each sheet. First, there came the total sales of that department for the previous year by months, and then for the year before that; opposite were the expenses for the two years by departments, itemized into the various expense accounts.

“Here is the proof,” I said. “It is absolutely correct, as your accounting system will allow ; and while your accounting system has not told you much, its original entries are doubtless correct. But I tell you here what the actual expense of each part of your store has been. When you come to think of it, you cannot expect it will cost exactly the same percentage of the selling price to sell a piano that it does to. sell sheet music or a library table or a book. Coincidences don’t come so uniformily. It may cost twice

as much, in percentage, to sell one article as it does another. Just because, to get your selling price, you mark all your goods up twenty per cent, from the cost price, you can’t be sure that it does not cost twentyfive per cent, to sell sheet music, and perhaps only five per cent, to sell chairs.” '

“But why is not your method as much a guess as ours?” Johnston asked. “How do I know that it cost $20 rent, for instance, for our sheet music department, and $24 for heat and light, and $520 for clerk hire?”

“Because it actually did,” I answered, and I proceeded to explain to him the basis of the figures before him. “It’s a very easy matter to determine the total clerks’ wages for any department for a year. It is merely the process of picking out the people who sell a certain line of goods and totaling their wages. It is just as simple to find the rent, the heat, and light for a department; that is a process of dividing the total number of square feet in the store by the number devoted to this department, and charging the same proportion of the year’s rent. The superintendence is a little more difficult, but that can also best be arrived at on the basis of space, as can also the general wear and tear of equipment.

“Administration and office expense are charged in proportion to the department’s volume of sales.”

And so I went through every expense account, showing exactly the basis on which the distribution was made.

Buried in the interesting details which I had opened up to him, the general manager failed to see the forest because of the trees.

“These figures are interesting and they will doubtless help the management of the business ; but how do they show what has been the matter with our profits?”

“Right here,” and I picked out five sheets from the pile. “You pushed two departments particularly hard this year, chiefly in order to overcome competition. You lost money on both these departments.

“You opened three new departments; one was very successful; the other two you lost money on. Now, why?”

“You lost money on library table? and display counters because you were bucking against competition ; you sold on too close a margin, did a great deal of advertising, and hired special salesmen. Your sales expense plus your general expense more than consumed your gross profit.

“You lost on sheet music because not only is the margin comparatively small, but each sale is for but a small amount. Then the department takes up a good deal of room ; it requires a great display space; you have a piano there on which purchasers try the latest popular airs. And your gross profit is, therefore, more than eaten up by your general expense in this department. The same applies to books.”

Johnston sat silent, his chin resting in his hand. He was waiting for more.

“Now take the year’s business ; subtract from your total expenses the expenses of three or four departments. The resultant profit would be larger than the actual profit you made last year, while the percentage of profit would show an even greater increase !

“I have shown you the cause. It carries with it the remedy. How that remedy should be applied is for you to say. Some of these departments you can doubtless drop ; others you must keep in order to hold certain business for other lines. In one or two of the departments you can make such changes that they will show the right margin of net profits.”

The general manager rose abruptly and picked up the sheets. “There is more important work for me to do today,” he said, “than sit at this desk. I am going home to my library to work this out.”

“Mr. Norman,” he said, his hand on my shoulder, “you have shown me the goal and the straight path. I have got to run to make it. The rest ought to be easy.”

And it was.