(Profit) Compression Algorithms

Making More Money in an Era of Declining Margins July 27, 2017

Scenario #1: It’s a hot, sunny day and you’re out mowing your lawn. Suddenly, you feel an extreme tightening of your chest so severe it takes your breath away. Before you can react, you fall to the ground losing consciousness. You’re having a heart attack. Luckily, a passing mailperson–who knows CPR–jumps into action, dropping down to begin pressing hard on your chest with rhythmic compressions. In this scenario, compression (chest compression) could save your life.

Scenario #2: You are the owner of a small-to-midsized AV integration company. You’ve just closed out another year and although sales are OK, your profits are down again. You pour over the numbers with your accountant and he points out the culprit: profit margins on the hardware that you’re installing are continuing to decline. In this scenario, compression (margin compression) could kill your business.

What Should You Do?

Integrators have complained for years that a combination of higher costs and lower average selling prices have combined to compress their margins. What can you do to re-inflate your profit margin?

Based on conversations with five top integrators, there are multiple factors that conspire to undermine your company’s ability to generate profit growth. Certainly one of those factors is a declining margin from predominantly hardware suppliers. But, challenging product categories can be a factor, too. For example, the inescapable dominance of video, which is often the center of a residential system installation, offers much lower margins than other product categories.

New technology trends also are powering the market in ways that are not always beneficial to integrators–at least in terms of profits. For example, the incredible growth of Sonos, an extremely popular wireless multi-room music system, is so strong that demand for the line with clients is increasing. But, like video, it offers integrators a much lower margin versus other brands. Caught in a Cornelian dilemma with no good solution, integrators must choose between either refusing to install Sonos and lose the job, or agreeing to install Sonos and make little or no money on the installation.

Attacking on Both Fronts

The simplified formula for gross profit is:

Revenues - Cost of Goods = Gross Profit.

So how is our panel of integrators able to grow profits in this era of declining margins? The answer: they attack the problem on both fronts, that is to say, on both sides of the equation, finding avenues to drive greater (profitable) revenues, while simultaneously identifying opportunities to reduce their costs or overhead. These opportunities exist; you just have to know where to look for them.

Justin Schwartz said although Sage AV has always done lighting control, it only recently brought its shades business in-house.
Ralph Tarnofsky, of Professional Audio Consultants, offers three levels of service contracts, based largely on three typical installation profiles.

Almost all of our interview subjects spoke at length about the strategy they’ve developed to conquer the issue of low profitability with Sonos installations. And a clear consensus has emerged: give your client a better sounding system that operates with the Sonos interface they desire, augmented with better performing, and more profitable, non-Sonos components.

“We actually do a ton of Sonos in-house,” said Justin Schwartz of Sage AV in New York City. “We are very adamant on leveraging the Sonos infrastructure and their interface via the Sonos Connect, but then putting in third-party amplifiers and speakers, and still maintaining the distributed audio profit centers that we normally would have [in other systems]. It’s a much better experience [for the client]. The profit margins are still obviously reduced, but not by much. Whereas, maybe on the Sonos Connect I’m only making 25 percent, but I’m making full margin on the amplifier…full margin on the wire…full margin on my speakers… and the client is getting a much better end-user experience.”

Ralph Tarnofsky of Professional Audio Consultants (PAC) in Milburn, NJ, said that when a customer insists on Sonos, “we’ll do it, but most of the Sonos systems we do are not simple–they’re almost always multi-zone, they almost always have better quality speakers flush mounted in the ceilings [and] in the walls, a good quality amplification, outboard DACs–we do everything we can to build around Sonos and make it sound good and get it to a profitable point by adding in all the better hardware to go with it. We tend to never sell those little wireless Play:1, Play:3, Play:5 things…barely ever sell those at all, because they are just completely not profitable and very limiting, and don’t sound that great. So our [approach] is a custom Sonos model.”

Adding New Profitable Categories

Navot Shoresh of Spire Integrated Systems works to move clients to higher performance categories that are more profitable.

By now, many integrators, including our entire panel, have discovered the many benefits of adding complementary product categories that not only drive added revenues, but also to add greater profitability. This is because many of these new categories, such as lighting, and motorized shades and drapes, are very profitable businesses.

“We work to move more [of our clients] to [more profitable categories] like higher performance audio, luxury shades–anything that is like added services, like acoustical treatments,” said Navot Shoresh of Spire Integrated Systems. “We’re also getting into other businesses, like light fixtures and other services.”

PAC’s Tornofsky offers Crestron lighting, shading, drapes, HVAC integration, or pretty much “everything you can integrate” on a Crestron or a Savant system. “We’re actually doing a job right now–it’s about a quarter of a million dollar project–in a big spec house that wasn’t pre-wired. It’s got 60 Crestron shades going into it, lighting control, and a nice family room home theater with Sonus Faber and McIntosh equipment. It’s a very nice project, but I would say that probably two-thirds of the budget for that project is the lighting and the shades – and the other third is the AV.”

Rob Kreatz of Audio Visual Installations & Design (AVID) has been adding categories like fireplaces and fountains to help increase profits.

Rob Kreatz, of Audio Visual Installations & Design (AVID), in Excelsior, MN, is adding categories, as well. “Yeah, we’ve added some [categories], like shades, lighting, security cameras, garage doors, fireplaces, pools, fountains, Tiki torches…um, you name it,” he said. “If you can close a circuit and turn it on…we like it.”

Networking has become a profitable category for Portsmouth, NH-based DC Home Systems, explained company president Nicholas Mark. “We sell Fortinet equipment, which doesn’t have much margin, but we sell it as a configured component,” he said. “So, we have indeed spent time coming up with our own configurations for these systems and our own way that they’re set up and racked. So we sell that as a kitted price, allowing us to maintain a full margin.”

Schwartz added that although Sage AV has always done lighting control, it only recently brought its shades business in-house and is looking into lighting fixtures, LED, and lowvoltage lighting. “Over the last two years, we’ve really increased our shades installs and sales. [Bringing shades in-house] was one of the best decisions I’ve ever made.”

Recurring Monthly Revenues (RMR)

There has been a lot written and discussed about the benefits of a recurring monthly revenue program, whether handled in-house or outsourced to a third party. To be sure, the integrators interviewed here were all involved with RMR–albeit at differing levels of commitment. Still, the benefits of a well-designed RMR program, in the form of a contracted service agreement for either remote monitoring or in-home services (or both) have not been lost on our panel.

“Recurring monthly revenue is always thrown around in this industry, where it’s kind of like, what’s the word I’m looking for–the elusive unicorn–with a lot of people saying it, but a lot of people don’t execute it properly,” Schwartz said. “I think we’re in a time of interesting change because I think more people are now getting involved in [service contracts].”

Schwartz acknowledged that his market (New York City) is a little different, in that none of his clients spend less than $2 million on an apartment. And then they don’t have the need for that much “stuff” because the apartments are a lot smaller. “So, a $2 million apartment is only going to be a two-bedroom apartment, and they’re only going to need four zones of music and maybe two thermostats.”

Therefore Schwartz’s clients are a little more willing to spend money on a service contract, he said, versus jobs in New Jersey where somebody spends $2 million on a house and they might have 15 rooms. “That’s a lot of stuff, so they’re not going to be as inclined to spend [even more money on a service contract],” he explained.

DC Home Systems’ Mark took his RMR services completely in-house. “Our approach has been that we do it based on the number of endpoints that we want to manage for the customer–endpoints being the devices in the house,” he said. “So we’ll have a conversation about ‘Here’s all the stuff in your house, maybe you have 200 endpoints. But really we don’t need to monitor everything, so let’s get this down to a chunk of stuff that makes the most sense for you.’ And then the next variable is how many times a month…a quarter…or a year do you want us to check these things? Basically, how needy are you? If it’s a summerhouse, maybe you’re only needy twice a year. But if you’re living there all the time, you’re going to be a little more needy, so we’re going to have that conversation. And it’s just basic math, and what’s nice about that is that it’s a very easy conversation with the customer in the sense that it’s not based on a percentage of the system [price] or some other arbitrary number; you’re actually calculating it with them [making it easy to adjust to any budget].”

Professional Audio Consultants offers three levels of service contracts, based largely on three typical installation profiles. “We have finally figured out our silver-, gold-, and platinum-level annual service program, but we’ve been rolling it out slowly to make sure the organization can properly scale to fully administer the programs,” Tarnofsky said. With package pricing running from $500 to $5,000 annually, PAC has an annual service program to meet any of their clients’ maintenance needs.

Spire’s Shoresh sees RMR a little differently, saying that Spire offers such programs, but that he doe not view them as a true offset to overall profit compression. “We’ve found that it’s more of a breakeven, and offsets some of the service cost,” he said.

Join a Buying Group

All of the integrators interviewed are in buying groups, and many of them credit this factor with helping drive down their costs. Thanks to a group’s combined buying power, products are often available at lower prices helping to improve their margin.

On the value of a buying group, Tarnovsky said, “We do try and buy right, which is also a helpful thing to improve the margin. Also [buying group programs] offer advantages like pre-paid freight, DFIs, and all that other stuff we get from the buying group. It’s very helpful and easily justifies the quarterly dues to be in the buying group.”

Focus Your Assortment

If you’re not careful, you will find yourself over-assorted with multiple products addressing similar uses. This is a trap that can add to your cost structure, without offering a meaningful additional contribution to your revenues. Our panel warns about this trend.

Networking has become a profitable category for Portsmouth, NH-based DC Home Systems, explained company president Nicholas Mark.

“Have the fewest number of SKUs you can have. It’s the gift that keeps on giving,” Nicholas Mark said, noting that with too many SKUs, you’re not supporting any one vendor, so you’re never going to “back anything out” in terms of rebates or discounts. “But more importantly, you’re going to make it harder to do anything efficiently in your organization because then you’ve got to have specialized people that only know a certain thing, and then they can hold you hostage with that. And you can’t have any backup stock because you have too many darn vendors you’re supporting. For me, that’s a major part of our strategy: to sell the fewest SKUs we can to accomplish the goals that need to be done.”

Tarnofsky said that instead of dabbling in Samsung, LG, Sharp, Sony, etc. and doing a little bit of business with each of them, his company threw almost all of its video business to Sony, and that it was enough to become a Diamond dealer. “I think we’re going on our third year, and we are enjoying better margins than we would have otherwise. It actually, in a lot of cases, takes our margins on projectors and flat screens to probably in the 25- to 30-percent range, which for video isn’t bad.”

Our panel of integrators offered plenty of other wisdom as well, including finding opportunities to mark up non-price sensitive infrastructure items, tightening up your operations to ensure proper billing of all design and labor charges, swapping out and selling higher-performance components for a better client experience and more profitability for the integrator, and pursuing faster, easier installs to offset profit margin declines with profit dollar increases. Or as Novot Shoresh puts it, “Pretty much the basics…right?” For more on these topics, check out the online version of this story.

A regular RS contributor, Ted Green publishes a widely read weekly CE business blog at Stata-gee.com, the online home of The Stratecon Group, his marketing and strategy agency for the tech industry.

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