Monetizing Supply Chain Excellence in Distribution

By Colin Carroll and Kim Long

Managing margins in distribution is a complex science in the best of markets, and today's economic climate — a tentative recovery with significant price volatility — amplifies distributors' profitability challenges. As customers watch their own businesses hesitantly return to growth, they will be trying to do more with less, increasing sales volumes without adding personnel or overhead. This nascent recovery is an opportunity for distributors to leverage supply chain excellence and add value, but it also means that customers will be looking to push costs onto their suppliers. Below we'll discuss best practices for customer-specific, supply-aware and competitive pricing strategies that will enable distributors to stop discounting away margins and uncover new profit opportunities.

The Ongoing Challenge: Customer-specific Costs

Distributors generally have a good grasp on service and supply chain costs at an aggregate level but struggle to assign specific costs to individual products, customers or services. This lack of activity-based costing means that sales teams quote prices with limited information about the cost or price of value-added services, bundling services as a way to win the order. This means distributors will lose money on some customers (usually those with the highest service costs). Supply chain professionals can help the front office by identifying the most expensive services and the most expensive customers to serve, and refining their commercial approach.

The days of using simple rules of thumb to price supply chain services are long gone. Progressive distributors can follow these steps to leverage supply chain insights to allocate their service resources in a way that maximizes return:

1. Define a customer classification model.

2. Identify a set of service offerings, independent of product.

3. Determine which subset of service offerings will be offered to each customer class.

4. Establish pricing policies for each service/customer classification combination.

Linking supply chain insights and capabilities with pricing policies and decisions can reduce margin variation and result in margin improvements of 75-200 basis points in the first calendar year alone. Distributors must link supply chain and cost-to-serve insights with customer pricing decisions in real time to reduce leakage, protect and increase margins, drive attach rates and inventory turns, manage service costs and leverage scale for efficiency.

Customer Classification and Segmentation

Distributors must understand the distinctions between customer types in order to intelligently construct the offer, the product-service bundle offered to each segment and the pricing policies associated with those unique combinations. Most distributors have some simple classifications today — A versus B accounts, key versus preferred accounts — and track end-use or SIC code. However, these are market segments, not pricing segments. Do A customers get a different service offering than D customers? Should they? Should all customers be offered the full service menu, with D customers paying more for rush freight and broken pallets than A customers?

Applying pricing policies to supply chain services can help distributors define a discount and cost recovery strategy for each customer class. First, a distributor needs to understand the cost of individual services and then make a strategic decision about how much of that cost to pass on to each customer class. The graphic below is a "cost-to-serve" playbook for a typical distributor.

In this case, A customers likely represent the highest margins. Therefore, does it make sense to provide services for free to these high-margin customers, or should the distributor charge them, assessing fees to customers who value these services? That is a strategic question. But it clearly does not make any sense to provide high-cost services to customers who do not value them or simply to the customers who yell the loudest. It is essential to manage this discipline at the time of offer as opposed to the time of price negotiation.