September 17, 2003 - Distribution Channel Commentary (DCC) # 39

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THIS WEEKíS TOPICS:

  1. Madonna as a role model for how to re-invent profit power (?)
  2. How to sell value better and do management opportunity triage; a case interview
  3. Distributor Case Study: How to crank a customerís contract prices 10%
  1. Madonna as a role model for how to re-invent profit power (?)

The Material Girl was recently on Oprah to promote her new childrenís book. She was fully and conservatively dressed, and she skipped the big, Brittany-Spears, lip lock with Oprah at the end of the session. When did you think you would associate Madonna with a book for your child? The last book associated with Madonna that comes to my mind was rated triple-X plus.

But, letís give her credit for being able to continuously reinvent her profit-power. Remember when she first transitioned from being a 19-year-old, U of Michigan cheerleader, dropout to making $90mm in just three years time? She has then gone on to reinvent her earning power about every three to five years. We may not like some aspects of her act, but she has not been afraid to work hard, work smart and have the guts to take risks and experiment to make it in a particularly competitive and unforgiving entertainment industry.

Maybe on a less frequent, more low-key and always dressed basis, we should be asking what we are doing to get truly fresh new insights for how to better describe and then rethink our distribution strategy to improve our profit power. Why should Madonna get all of the material wealth, letís create some of our own!

If profit before interest and tax (PBIT) improvement is a good measure of wealth creation, why not rethink our customer portfolio by ranking customers by estimated PBIT contribution. Then, think about which (potentially) profitable customers have proven, over the past 5 years, an ability to grow faster than their industry competitors. Here is what the typical distributor would discover:

  • 20% of our truly best accounts generate 150% of our profits (not from sales or gross margin dollar rankings, but from profit before interest and tax ( PBIT) rankings)
  • The bottom 20% destroy 50% of our PBIT (this hurts all other stakeholders; why do we allow it?)
  • The middle 60% average a break-even activity fest. How can we boost their average PBIT?
  • Only 5% of the customers in a mature, consolidating industry will generate 80% of the future PBIT growth for suppliers to that industry segment over the next 5 years. How can we get them to marry us?

Why try to write new, best-selling childrenís books when we have such big PBIT improvement opportunities within our own customer portfolios? If you would like about 20,000+ more prescriptive words and some great pictures about "reinventing your profit power":

  • Go to www.merrifield.com
  • Look for the red star on the home page
  • Download and print "Chapter One" of our forthcoming book (a heavily revised up-date was posted last week)
  • Skim through the chapter to look at the 10 or so graphs
  • Read the case study at the end on ABC Distribution Company
  • Then, read the entire chapter in detail, if you are still on the hook.

If you are frustrated because you havenít been able to get traction with some of the ideas in Chapter One, then you might want to:

  • Go back to our homepage and download "Chapter Two", which may help you to systematically name some of the flawed, financial-management, operational assumptions that may be limiting progress.
  • Or, read the following case studies for ideas on how to focus your scarce resources like a laser-beam on the highest return spots in your business.
    2.    How to sell value better and do management opportunity triage; a case interview

I was recently interviewing the CEO of a regional distribution chain who is also, for this year, president of his trade association. The association members sell components to mostly small fabricator type businesses. The purpose of the call was to get some industry background information to help me prepare a presentation that I will do to for his group later this fall.

During our phone conversation two topics surfaced for which we reached some conclusions. Because they are common pain points Ė getting paid for value and managing time better Ė I thought I would share them.

First, he was dismayed at the general inability of companies in his channel to "SELL VALUE". The specific incident that triggered his frustration involved a new product technology that had about a 20% higher price than the old technology item that it should displace. The fabricator customers who would buy this breakthrough item could easily determine that the new product would measurably generate about 40% more in total savings. The simple math of the matter was: pay 20% more to save 40% for a net of a 20% gain on the total cost of the final product.

My new friendís frustration was that a competitorís sales force was out selling the product at 15% off in order to compete with the old productís price. It reminded me of a similar story from my personal distribution channel selling days (in a past life). A customer laughed as he told me about how much he liked a new, superior productís savings and would have happily paid the higher price, but the sales rep offered him a deal, so he took it.

Think of the long-term, turn-earn inventory math for distributors that stock the aforementioned, new item. First, a distributor doubles their inventory investment, because they will now stock both the old and new solution. Then, in theory, sales might someday increase 20% if the new product eventually displaced all sales of the old item. But, if competitors cut the margin 15% to be price-competitive to the old product, then the incremental margin dollars will only grow by 5% as the final inventory investment gradually drops to a 20% increase. The final turn-earn for the new product will be about half of what distributors are currently getting on the old product!

Who is economically winning in this picture? The manufacturer of the new stuff is delighted that sales are growing faster than anticipated because distributors are willing to stock and make a market for it by educational selling and cutting the price. The customers are winning, they pay 5 to 10% more to get a slam-dunk net savings of 30 to 35%. But, the distributor(s) will not recoup their market development costs, and they will achieve the eventual, lower, turn-earn we calculated above.

Whatís the solution? How can my friend get his competitors to be smarter? His industry service is part of the answer, I have always been a big believer in educating my competitors on how to sell value. As illustrated above, dumb competitors cause losing economics for all distributors.

We also agreed that there are more aspects to the selling value problem. Besides product value selling, can reps sell the value of:

  • Themselves?
  • The companyís basic service value proposition?
  • The total cost savings that might come from buy-sell process re-engineering or extra services for fees?

If one of your reps is offered a last-look to meet the price, can they insist on keeping the business AND getting a bit more just for their own unique value added contribution to the customerís bottom line? In theory, if they have been delivering individual, unique value-added activities to the customer to effectively put extra bucks to the customerís bottom line, then arenít they entitled to a fraction of that incremental profit action? If they settle for meeting the price, arenít they admitting that there is no historical extra value-added that they have generated for the customer as the majority, incumbent supplier? If you canít sell yourself, can you sell incremental total product or service value concepts?

We agreed that the sequence for rehabilitating the lost art of selling service value might be the abilities to:

  • Sell yourself for last-look plus
  • Sell better, total value products at higher total-value supported prices (his immediate concern)
  • Sell better, total-value, basic service excellence (if the company has it!)
  • Sell better, total-value, extra services that take business process costs out of the buy-sell replenishment activity between the two firms.

But, where could my busy friend find the educational solution for value selling that was distribution-specific, affordable and effective? I modestly suggested our "High PerformanceÖ" video in which 13 of the 53 modules (#s 4.1-4.13) are aimed at " defining, measuring, achieving, selling and leveraging (through routinization) service value". He ordered the kit thinking that the 30-day, unconditional guarantee and trade association re-seller price was too good to be true. (Check out the videoís story in the center of our home page.) But, this raised a second big concern of the conversation.

"Where am I going to find the time to preview this educational product and then preach and teach it?" We agreed that everyone was super time-pressed in this cut-back, work harder economy and that classic time management theory would advise us to practice triage, just as they do in emergency rooms. Setting priorities in the ER is visually pretty easy, we would just take care of those people who are dying the fastest first; then the slower dying ones; and then the broken, but not dying.

What is the one best factor we might use for prioritizing management opportunities in a distribution business? Rather than get caught up in best practice time management stuff, what if we thought in terms of strategically best wealth creation for a given distribution location. Try this experiment: keep asking yourself:

HOW WILL ADDRESSING THIS PROBLEM HELP US TO IMPROVE OUR PBIT LINE THE FASTEST? MORE SPECIFICALLY, WHAT ARE WE DOING TO:

  • RETAIN AND GROW WITH OUR MOST PROFITABLE (and ambitiously progressive) CUSTOMERS IN OUR NUMBER ONE NICHE OF CUSTOMERS?
  • CONVERT BIGGEST LOSING ACCOUNTS INTO PROFITABLE ONES?

When we do simple, PBIT contribution ranking reports for customers by company, location and sales territory, all activity decisions are seen in a dramatically different light. I suggested to my new friend that for triage ideas he might:

  • Skim through the following articles posted under "articles" at www.merrifield.com: #s 2.15, 2.3, 2.19 and then 2.16.
  • Read the following case study in which a distribution chain added a new, one-page summary sheet to every branchís P&L report. This page asked what was the branch doing for the listed accounts that were roughly: the 5 most profitable ones, the 5 most important target accounts and the 5 biggest losing accounts. After 3 to 6 months, local and regional managers started to allocate scarce time to doing proactive things for those accounts that could make the biggest, fastest, bottom-line improvements.
   3.    Distributor Case Study: How to crank a customer contractís prices 10%

One of our video users recently reported the following, happy case story. The company is a regional distribution chain (letís call them XYZ Supply) that sells MRO (maintenance, repair and operating) items. They have, in the past 7+ years, grabbed some "integrated supply" deals. Some were simply next-step progressions with customers for which they already had special stocking, in-plant service replenishment deals. Some of these deals dated back to the early Ď70ís. Others were big, new volume wins that ultimately turned out to be big losers, because all of the total costs to serve were not anticipated up-front.

The CEO had done the PBIT ranking reports referred to in both topics 1 and 2 above and had been pursuing a number of the specific plays that such reports naturally suggest and support (the plays are all in the video). One of the plays is to attempt to turn biggest losers into winners by pitching such customers on the fact that both companies are killing each other with small order transactional costs. About 80% of these "lead" accounts can be turned into "gold", because they will generally go along with some re-thinking, re-tuning and even re-pricing of the deal to make it a better total cost/profit deal for both parties.

XYZ had one customer, however, (letís call them BigCo) for which the contract was quite involved and there was no easy way to reduce the huge amount of small orders. Moreover, BigCo was adamant that they were not going to yield any economic concessions. BigCoís main messages were:

  • XYZ didnít know their true costs and was surely making enough on the contract.
  • Other suppliers would be delighted to take XYZís place.
  • Central Purchasingís policy was to E-bid any contract before giving any additional concessions.

So, XYZ decided to help BigCo do an e-bid by making sure every (costly) detail of the agreement was included in the proposal. Before the e-bid exercise, XYZ had been averaging an 18% margin on the entire contract and had decided that if the bidding got below 23%, they would drop out because a 23% rate would be just above break-even on a fully loaded cost allocation basis.

In the actual reverse auction, bidding process, three other firms participated, and the last one dropped out at 28%. So, XYZ kept the exact same contract at a 10% higher price!

What happened? What are the lessons of the story? My client concluded the following:

Itís good to know the true costs of serving a customer. After doing the simple, PBIT ranking report, a team of people did a more detailed analysis of the "true" costs for the biggest losers. The first level of PBIT analysis showed BigCo losing $80,000. After a detailed analysis, the size of the costs for both special stock and remote deliveries were bigger than "average". The account was losing $100,000 on about $2 million in total sales. The e-bid exercise win will generate a roughly $200,000 positive PBIT swing to the two branches involved for each of at least three more years of the contract.

The new one-page summary report that each location gets with their monthly P&L was responsible for getting a regional manager and two branch managers to eventually focus on solving the BigCo opportunity. They did nothing about BigCo for about 4 months, but then the three of them got sick of noticing not just the big losses, but all of the daily service compromises that had to be made for BigCo at the expense of not doing things for the most profitable and high potential accounts. The new metrics finally caused a spontaneous shift of management time from fire fighting routine, familiar operational problems to tackling the #1 most PBIT improving opportunity they had.

The bid drop-out rates were surprises. XYZ had assumed that one of the other participants would surely go below 23% margin, and they had contingency plans for what they were going to do with the two branches for which the BigCo contract was over 25% of the total sales.

Why did they drop out? Who knows. Some theories were: the would be suppliers were better educated, because XYZ had been able to detail all of the expense angles into the e-bid. The other bidders were much more careful, because their bottom lines were already hurting with the bad economy and their own collection of integrated supply losing contracts. Economic pain does apparently instruct most distributors after 7+ years of too many losses on too many big integrated supply contracts. The "volume is vanity, profit is sanity" lesson may be sinking in again in this particular channel.

What will XYZ do going forward? They are using this case study as an internal motivation story, and they are now asking other big losing accounts if they would like assistance in e-bidding the contract!

How are both your management and sales teams using their scarce, proactive time to make the biggest, fastest PBIT improvements for your company?

Thatís all for this week!

Bruce

bruce@merrifield.com