Spend enough time with a distribution executives and you learn some common principles they tend to adopt. Many are accurate, but a few are way off-base. Here are three commonly held beliefs distributors need to abandon:
1. Growing margins forever is the best strategy.
Measuring profitability by enterprise gross margin is a sledgehammer approach to a problem requiring nuance and precision.
No matter how good you are at pricing contracts and transactions, there are situations where you could have gotten more profit some of the time from some customers. And there are other situations where you set prices too high and lost the business. So, we believe it’s essential for distributors to develop sophisticated pricing practices and to utilize good pricing software.
And yet…it’s possible to price yourself out of the market. No matter how great your value-added services, sometimes customers just want an easy way to order products that are priced fairly and delivered promptly. The hypothetical world’s finest distributor can’t add much value to a typical order for double A batteries. If your company regularly tries to squeeze another 10% or 20% out of these orders, some customers will eventually deem you as overpriced.
When D.G. MacPherson became Grainger’s CEO, he took a lot of heat from analysts for lowering prices. But Grainger had priced itself out of the market on many items, and we believe this recalibration of profitability towards market levels jumpstarted new business for the company.
The philosophy of profitability that relies on margins going up forever is not realistic. Too often, executives set aggressive margin growth goals without a thoughtful and sophisticated approach and the result is a reputation for high prices that’s difficult to repair.
One of Jeff Bezos’s famous quotes is: “Our profitability is not our customers’ problem.” That means you have to be competitive in the market and then figure out how to operate your business to achieve an acceptable level of profitability. Simply raising prices quarter by quarter, and year by year, makes your profitability a problem your customers will solve by buying from your competitors.
2. Price is your only lever for growing profitability.
“Pricing” is so closely correlated with improving financial returns that, according to LinkedIn, there are 24 times more people with the title “Director of Pricing” than “Director of Profitability.” This is absurd because pricing is only one component of profitability, but it gets almost all of the attention from many distributors.
Profitability begins with buying from suppliers at the lowest possible prices. However, many distributors have dozens or hundreds of untrained, amateur “purchasing agents” spread across the organization doing spot buys from manufacturers and other distributors. This is a particularly egregious problem when a distributor’s customer service personnel – who are noted for their “mission of service” orientation and tendency to avoid confrontation – are doing the buying. Of course, these individuals are turning around and setting the selling prices to your customers as well, so you have the nicest people in the company buying from professional sellers and selling to professional buyers, and your buyout margins probably show it.
Worse, you may not be able to analyze this sloppy buying and selling because “buyouts” like this are often transacted under generic SKUs. If you do dig into the problem, you’ll likely find that a portion of your buyouts are actually stock items that someone sourced just so they could sell below allowable margin levels.
Sophisticated distributors centralize as much buying as possible, not only to avoid these issues but also to take advantage of volume discounts and set rebate and marketing co-op levels. I’ve worked with distributors where we put nearly every vendor into a Strategic Buying Agreement (SBA) , almost all of which had at least some level of rebate and co-op percentages. At the end of the year, we’d simply bill dozens of suppliers based on the agreements. This can add up to millions of dollars for a large distributor.
If you aren’t measuring the proportion of your purchases coming through SBAs, you should start. Centralize your purchasing as much as possible, take buyout responsibility from everyone except those who are trained to do it well, and you’ll improve your margins without touching customer prices.
3. The higher proportion of digital sales, the better.
Most distributors we work with measure ecommerce ROI like this:
Numerator: Shopping Cart Gross Margin Dollars
Denominator: eCommerce Capital Costs
eCommerce Expenses (Labor, Ongoing Fees, etc.)
This is a simple and reasonably accurate measurement methodology for a retailer and a ludicrously misleading and damaging approach for a distributor: Most business customers rarely check out through your shopping cart with a credit card. That’s a retail measurement. Distribution customers often shop online but they prefer to buy with POs that they send by email or EDI, or they call them in over the phone. This means the most common distributor ecommerce ROI model accurately assesses expenses and wildly underestimates benefits. No wonder most distributors won’t invest more in ecommerce.
It gets worse: In a misguided effort to pump up the numerator in this model, many distributors will try to persuade customers to complete their purchases online even if they don’t want to. We’ve seen distributors offer special online discounts or even sales force incentives an in attempt to grow the amount of revenue going through the shopping cart.
We understand this temptation, but as we heard Michael Dell say on a conference call once, “If customers want to order by smoke signals, we’ll learn how to read them.” In other words, you want to make sure customers can order the way they prefer and not try to bend their behavior to your flawed ecommerce ROI model.
Another problem we’ve seen is that many major distributors – especially public companies – have been rewarded by Wall Street analysts for demonstrating dramatic growth in the proportion of their sales coming from digital channels. As a result, some distributors have become obsessed with driving up that number, bragging that 50%, 60%, 70% or more of their total revenue is coming through their websites, EDI, etc.
Analysts are not distribution strategists. They have made simple and wrong-headed conclusions that distributors with a greater proportion of ecommerce revenue will get more efficient and achieve Amazon-like multiples. Of course, one outcome of chasing shopping-cart revenues at any cost is that you begin to eliminate anything that’s not digital. You start ignoring what customers want and, instead, prioritize ecommerce at any cost.
The result is that some distributors have eliminated most of what differentiated them from pure online sellers and became more like Amazon instead. This has moved them right into the target zone for digital competitors, who can easily pick off these online, undifferentiated revenues.
Customer needs – not analyst opinions – are your North Star
Your strategy should always start with the customer – not analysts or other stakeholders. We’ve seen over and over again that the way to meet shareholder requirements is to understand and satisfy customer needs better than your competitors do. Obsessing over charging higher prices to achieve margin growth or trying to manipulate buyer behavior to meet internal measurements is the opposite of customer-driven.
We all know how we want to be treated as customers. A Vice President of Sales I used to work with once told me, “My litmus test for whether or not we have the right sales training materials is to ask, ‘Would I be embarrassed if our customers saw them?’” Apply a similar litmus test to your strategic initiatives. Buying smarter so you don’t have to raise prices would meet with your customers’ approval. So would making sure your customers can buy easily and confidently through whatever channel they prefer. Reach out today to talk with us about how we can help you understand your customers better.