Just what do we mean when we speak of GMROI? Also commonly referred to as GEM-ROY. GMROI is an important measurement of a business and its profitability. GMROI also gives us a comparison as to how profitable a business is compared to its industry.
Recently a co-worker called me and asked me to consult on GMROI in 3 minutes. I asked, “What is your number?” The customer answered, “229”. My answer, “You should package it up and franchise it!” Man, I was seriously all wet. 7 months later, I was asked to take a deeper dive into helping with this customer’s GMROI problem. What did I miss? 229 was poor in this customer’s industry. His industry average is 360.
Wikipediadefines GMROI like this: Gross Margin Return on Inventory Investment (GMROII) is a ratio in microeconomics that describes a seller's return on every unit of currency spent on inventory. It is one way to determine how profitable the seller's inventory is and describes the relationship between the profit earned from total sales, and the amount invested in the inventory sold. Generally, for a seller, the higher the GMROII the better. Since the inventory is a very widely ranging factor in a seller's investment in working capital, it is important for the seller to know how much he might expect to gain from it. The GMROII answers the question "for each unit of average inventory held at cost, how many units of currency of gross profit I generated in one year?"
In summary, GMROI should equal 100 or higher. This means for every dollar of inventory invested, it returns at least one dollar or break even. In theory, GMROI of 120 is about 20% GP.
Why did I goof by stating, “you should package up 229 and franchise it?”. I work in a mature industry that mainly revolves around electrical and plumbing distributors. Rarely do I see a GMROI over 125. Let’s face it, products developed by Nikola Tesla and Thomas Crapper haven’t changed much in the past 100 years. As a result, this is a very mature industry that has pluses and minuses.
The plus? Mature products that are a part of the basic grid don’t change much. Therefore, inventory investment will appreciate with price increases. What was a good part 10 years ago, is a good part today?
The minus? Margin, margin, margin. Mature products have commoditized, and price margin is minimal. Many times, electrical and plumbing distributors have GMROI less than 100. How is this possible? Direct shipments and services result in an industry average of 3%-4% EBITDA.
Mature business can only increase GMROI by increasing turns and decreasing inventory value. It’s imperative to use an ERP system that calculates demand accurately and optimizes economic order quantity based on real carrying cost.
Kelly Johnson is business consultant and on-site trainer for Zerion Group.