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.
|Customer Class||Strategic (A)||Value (B)||Price (C)||Opportunistic (D)|
|Delivery Standard||Waived or Negotiated
||Fixed Fee||Full recovery||Full recovery|
|Delivery—DeskTop||Waived or Negotiated||Negotiated - full cost recovery||Fee for service||Fee for service|
||Allow price||Negotiated||No price||No price|
|Inventory Customer Unique Products
||Allowed/Negotiated||Allowed/full cost recovery||None||None|
|Rush Orders||Allowed||Fee for service||Fee for service||Fee for service|
||Sales Rep Assigned||Customer service||Online only||Online only|
Disciplined offer management and service-cost playbook enforcement will reduce negative margin variation. These small changes will help distributors allocate service resources only to customers who are willing to pay for them. It's only with visibility into supply chain costs that this level of targeted offer and price management becomes possible.
Supply-aware Discounting Strategies
Another way supply chain professionals can add value to a distributor's commercial organization is to help inform discounting behavior. It is a pricing best practice to reduce discounts, or to increase prices on products in short supply. As inventory levels go down or order velocity increases, most distributors will want to price differently. Simply having visibility into current stock levels may be insufficient for informing pricing decisions, but insight into the trends, velocity and current stock levels is essential to informing inventory-aware pricing behavior to increase margins.
Certainly supply chain organizations add value by understanding actual service costs at the customer level and accurately forecasting service costs on new opportunities. In addition to understanding customer-specific service costs, best-in-class distributors actively benchmark competitor costs.
Distributors know the shipping cost, but do they know what it costs their competitor to make a comparable shipment? There are tough decisions to be made here. If the distributor has a cost position advantage, should they pass that savings on to the customer? Or should they match the competitor's price and keep the savings as incremental margin?
In many industries, competitor supply chain costs can be factored into pricing decisions for dramatic improvements in margin realization. The cost-position advantage can be utilized to win deals and increase share or, in some cases, to increase margins.
Validating Competitive Situations
Another way that supply chain and commercial organizations can increase revenue and margins is through the validation and qualification of competitive situations.
Distributors are constantly responding to competitive pricing situations, and it's important to determine the service level of that price. The best practice is to validate each competitive situation in a structured way to determine the service component and respond appropriately. For example, has the distributor answered these questions?
1. What good is that low price if the delivery won't arrive for three days?
2. Who is the competitor and what is their price?
3. Is that price delivered next day by noon? What services are included?
4. Is that price net of rebates and programs?
Tracking competitive situations and service levels allows distributors to occasionally call a customer's bluff. If they know the competitor can't deliver the same product/service bundle in the same delivery window, they can price for margin as opposed to share.
Similarly, understanding the customer's cost of use can help increase price and margin realization. If the distributor knows that some customers have very little room for inventory, that knowledge can help them determine a service level and discount strategy for that customer. Because downtime and production delays are more expensive for some customers than others, insight into the extended supply chain can help the commercial team make better pricing decisions.
The days of treating the supply chain as a mere cost center to be allocated are long gone. Today best-in-class distributors continue to take cost out of their supply chains and turn their supply chains into sources of competitive differentiation and profit centers. Better customer-specific costing leads to better allocation of service resources, and better price and margin realization. A close linkage between supply chain insights and commercial decisions helps distributors identify and exploit margin opportunities.
About the Authors: Colin Carroll is vice president of business consulting at Vendavo, and Kim Long is a senior business consultant with Vendavo. For more information, go to www.Vendavo.com.