To improve profitability most distributors should become much more expensive customers for their suppliers.
Instead, distributors often initiate profit-maximizing plans by figuring out how to charge more from customers. Meanwhile, your suppliers are doing the same thing to you. I suggest you learn how to buy smarter so you can raise your margins without charging your customers higher prices first. Managing pricing is a very important activity – but it applies to your “buy” as well as your “sell” prices.
I was recently reminded of this when I read a column by David Gordon, president of Channel Marketing Group, called MRO Buyers Primed for New Suppliers. David reported on a recent call he participated in during which “A couple of manufacturers commented that Amazon Business is their most expensive customer (selling their products as a distributor).”
Amazon doesn’t report on the financial performance of its B2B marketplace, but Morgan Stanley estimates that third-party sales contribute about a 20% EBITDA margin to the company. If that’s true, Amazon is driving extraordinary profitability while selling at generally-competitive prices.
Undisciplined Purchasing Punishes Your Profits
Large, sophisticated retailers wring profits out of their purchases with many inventive techniques, such as using “most-favored-customer” contracts in which suppliers agree to sell at whatever the lowest-used price is for any reseller. Big distribution companies apply centralized procurement, annual purchasing agreements and other tactics to squeeze down prices while pumping up rebates and co-op from manufacturers.
Meanwhile, on the other end of the spectrum sit most distributors, many of whom have dozens or even hundreds of inside and outside sales people making purchases every day. Some of these companies eventually attempt to centralize a portion of their purchasing and that’s when they discover that they don’t have the data and processes necessary to buy at the lowest-possible prices:
- Much of what the field people purchase isn’t properly classified, so the distributor can’t identify the product or, often, the manufacturer. This is particularly true if some of that sourcing is from other distributors, which is a great way to ensure you’re overpriced.
- A lot of the “spot buying” happening in the field is in reaction to inventory shortages. Combined with the lack of product data, that means your already-flawed forecasts automatically get worse. That leads to more spot buying and even worse forecasts.
- Customer and market intelligence your field people have doesn’t make it into a demand-planning model because there’s no process to capture it. Also, there’s not much of a demand-planning model.
- Suppliers launch promotions throughout the company that aren’t coordinated with purchasing or inventory management people. You suddenly run short of a key product across your branches because one location is selling it at lower price and you don’t know it.
- You don’t negotiate supplier participation in your product promotions – meaning they’re not offering reduced costs or reimbursing you for “instant rebates” or package deals.
- Rogue suppliers sell throughout the network, meaning you aren’t consolidating your purchases or accurately tracking demand for what are really different brands of the same product. That raises your inventory levels, lowers your service levels and reduces your profitability because you’re buying in small quantities at artificially high costs from several suppliers.
When I was in business school, we had a term for this kind of business problem. It’s called “madness.”
Curing Purchasing Madness
Inventory management is not category management. Neither is purchasing. The former is about working capital performance and the latter is primarily about replenishment. Exactly what inventory you should be managing and replenishing – and getting it at the lowest cost on the best terms – that’s category management.
Just because you aren’t a part of a large distribution company doesn’t mean you can’t generate enormous profit improvement from buying more strategically. For that matter, a lot of large distributors don’t buy very well, either.
Regardless of the size of your company, you need to put in place processes that enable you to:
- Know what you’re buying, stocking and selling. You must have detailed product information about everything that’s in your buy/sell transactions and on your shelves. Can you imagine Home Depot, Grainger or Walmart allowing a bunch of anonymous SKUs populating their sales records?
- Build a demand planning process to incorporate customer intelligence, market information, promotional activity, etc. You must know the inputs that drive your demand so you can forecast better. Forecasting well is very difficult even with perfect information. It’s impossible with major data components missing.
- Put business rules around your purchasing. Centralize where you can and make people accountable for the performance of the products they buy. Identify approved suppliers and closely monitor all purchases that go to other manufacturers.
- Create a category management function. Whether you’re a small or large company, someone should have responsibility for your supplier, product and negotiating strategy. In addition to lower prices, you’ll find pools of profit available in the forms of rebates, marketing co-op, freight terms, and more.
For a quick overview of these concepts, I suggest you attend MDM’s free webinar tomorrow, Targeted Strategies to Optimize Sales, Inventory & Operations Planning, led by veteran distribution executive, Brad Johnson, who is a category management and supply chain expert.
Brad will also be conducting a pre-conference workshop and delivering a keynote at our upcoming Distributor Pricing & Profitability Summit in Denver, April 15-17. Given how critical good purchasing is to maximizing your profitability, can you afford not to send someone to learn how to do it better?
Feel free to leave a comment below or email me at [email protected]. See you in Denver.