Working capital and GPI.

Distributor profits in the area of electrified security products is once again the topic of this column. As in the past few months, I will continue to address this topic, which is based on a research publication commissioned by the DHI Education Foundation titled, "The Financial Opportunity in Electrified Products," by Dr. Al Bates of the Profit Planning Group. Dr. Bates has been producing DHI distributor financial reports for many years and was a featured lecturer on this topic at the "Forum for the Future: Business Strategies for Electrified Products" conducted by the DHI Education Foundation this past Fall.

The investment challenge

The necessary investment to enter the electrified products market by moving a company from a traditional operating mode to one involving higher levels of technology and a modified service component can be intimidating. Often the financial point of view is that the typical firm can't afford to make the investment required to change. The marketing view is that the firm can't afford not to make the investment - a difficult choice.

The "investment challenge" can be considered from three standpoints: working capital, fixed asset investment and the one-time cost of entering a new business. This column will focus specifically on working capital.

According to Dr. Bates, the challenge is to have adequate working capital to support increases in both inventory and accounts receivable as new product categories are added. Although this may appear to be a daunting undertaking, in reality it is very modest.

The growth potential index (GPI) is the best measurement tool to determine how fast a firm can grow. This ratio estimates how fast the firm can increase its sales each year with internally generated funds. The GPI for the typical DHI member is around 9.8% - meaning that a firm should not have to seek outside financing if it experiences an increase in sales of up to 9.8%. Whether the GPI is high or low depends upon the growth opportunities facing the particular firm.

In fact, the 9.8% is below the actual sales growth generated by members of the Door and Hardware Institute in recent years. If the firm faces major growth opportunities, such as with electrified products, the clear strategy is to increase the GPI. Dr. Bates states that the best way to do so is by increasing profits. As always, increased profitability solves a great deal of problems.

Fortunately, the firms that have moved into electrified products early have experienced greater profits. Once the new products are added successfully, the funds for growth should become available. This is partially because in the door and hardware industry, as in most other industries, "those firms that stake out a position in higher technology products tend to perform better than those that do not," according to Bates. Suppliers of electrified products are "part of exclusive networks where both margins and expenses are increased," Bates says.

The bottom line...the GPI is an essential ingredient in planning. Firms anticipating an increase in sales - either with or without a move into electrified products - should carefully consider their GPI when evaluating working capital. Trying to move significantly faster than GPI is a recipe for disaster.

Next month's column will address other aspects of the investment challenge.

If you would like to purchase a copy of "The Financial Opportunity in Electrified Products," contact the DHI Education Foundation, 703/222-2010; Fax: [phone]. Copies are available for $20 each.