The authors of Value Creation Strategies for Wholesaler-Distributors implore distributors to define strategy in terms of closing gaps with the market rather than operational weaknesses. Tactically driven initiatives may meet intermediate goals, but they often produce unsatisfactory business outcomes.
This is an excerpt from Value Creation Strategies for Wholesaler-Distributors reprinted with permission from the NAW Institute for Distribution Excellence. Order the book at www.naw.org/valuecreationstrateg.
Strictly speaking, best practices are business operations that are statistically correlated with superior financial performance. The study of best practices is now widespread and has contributed to significant productivity improvements by wholesaler-distributors across all lines of trade. The most comprehensive review of distribution best practices was the 1996 report Facing the Forces of Change: Transforming Your Business with Best Practices, which examined more than 150 business processes (Arthur Andersen, 1996).
The best practices approach originated from a simple, almost obvious premise: At some level, most business organizations do the same things. Therefore, by emulating high-performing organizations’ processes, we can quickly find ways to improve our own business. Intriguingly, best practices offer a way to learn from any organization in any industry, provided that both organizations share a common process.
One of the most beguiling aspects of a best practices approach is that it offers a straight path to the solution without detouring to examine underlying assumptions, market forces, or organizational problems. Our research indicates that wholesaler-distributors are especially susceptible to this enticement. Their culture of responsiveness can make them impatient and skeptical of overly complex analysis.
As a result, they are more likely to initiate process improvement projects for tactical rather than strategic reasons. By this we mean that the justification for the project was a perceived deficiency against some form of best practices standard rather than an opportunity to close a market gap. It is important to emphasize that tactical does not necessarily mean bad. We explore the implications of bottom-up versus top-down process improvement in the next section.
Improvement projects often spring from the perceptions of a problem (such as losing sales events) for which wholesaler-distributors seek a straightforward solution (such as more training). This approach is consistent with the world view of winning more events than losing, which we described earlier. Based on a sample of current and past projects undertaken by many companies, more than two-thirds of major wholesaler-distributor process improvement initiatives are driven by tactical considerations instead of closing market gaps.
Most Common Improvement Projects
Here are the most common process improvement projects:
Sales force automation (SFA) and customer relationship management (CRM) software. These projects are often begun as a reaction to falling sales, lagging sales force productivity (usually based on line of trade benchmarks such as performance analysis reports) or a perceived lack of accountability or motivation on the part of the sales force. Software vendors offer canned best practices and tout improbable sales growth figures.
Training. It is hard to argue with the “more is better” attitude toward training, so this is a common solution for a wide variety of problems. Training courses are often used to educate staff on “what we need them to do,” focusing on motivation as much as skills development.
Inventory management. These projects are usually initiated to address poor inventory turns (again, usually based on line of trade benchmarks) or perceptions of inadequate fill rates. We use the term perception because it is surprising how few wholesaler-distributors measure their true customer service levels reliably. New software usually plays a big role in these projects.
Pricing. At an executive level, pricing initiatives are sold as a simple matter of increasing gross margins. There is usually more skepticism farther down the organization, where the inherent risks of snapping customer trust are often more fully appreciated. These projects typically attempt to do two things: apply mathematical algorithms to identify opportunities to increase prices and apply process changes to reduce sales rep discretion in pricing.
Unfortunately, by using best practices as a starting point, wholesaler-distributors often end up creating initiatives that are poorly aligned with their market positioning. Although they may or may not actually degrade the company’s value proposition, poorly aligned projects represent a diversion of resources and focus from more strategically vital areas.
Solution First Falls Short
Our research revealed an interesting pattern of outcomes. Tactically driven initiatives tend to have higher success rates in meeting intermediate project goals, but they often produce unsatisfactory business outcomes. More strategic projects are often difficult to execute, but when they are completed they can have a striking impact on bottom-line performance. The link to strategy tends to make these projects “big effort for big reward” propositions.
Some examples of tactically driven initiatives from our research are as follows:
A large computer products distributor consolidates its distribution centers and decides to implement a new warehouse management system (WMS). One of the primary goals for the WMS is to increase picking productivity.
Pickers represent the majority of its warehouse staff, and informal benchmarking indicates that the company lags behind its peers in lines picked per man-hour. The distributor designs a highly automated outbound process that incorporates carousels, a pick-and-pass conveyor system, and batch picking for high-velocity items.
The company succeeds at greatly improving picks per hour, but pays a huge price: It finds itself no longer able to meet its 7 p.m. shipping cutoff time and experiences considerable sales erosion as a result. This company failed to recognize that a large portion of its customers (smaller retailers and system integrators with limited working capital) opted to place orders for overnight delivery late in the day, after they knew what they would need for the next day. As a result, 90% of the distributor’s orders were received after 4 p.m., creating a very narrow window for processing them in the warehouse.
In its old warehouses the company could simply flood an area with pickers to meet the deadline. In the new, modern distribution centers, the carousels and conveyors created a rigid bottleneck. Ultimately, all the expensive equipment had to be ripped out. From a market standpoint, the ability to compress a day’s worth of activity into a three-hour window was far more important than the “efficiency” of the process. The solution was based on measuring the wrong thing.
An office products distributor becomes anxious to consolidate its supplier base. It believes that by carrying “12 different kinds of toilet paper,” it is foregoing volume rebates from vendors and reducing service levels to customers. The distributor convenes a cross-functional team to tackle the problem.
The team makes quick progress, developing a list of preferred vendors and products for an entire category. But the project stalls when sales reps are asked to convert customers from their current brands to the preferred suppliers. How hard should the company push a reluctant customer? How much time should reps divert from creating new sales to converting existing sales? Which customers are too important to risk? Which suppliers are too important to ignore? The distributor realizes that these questions are impossible to answer without a more clearly defined strategy.
Based on benchmarking studies, a consumer products distributor determines that its operations and customer service costs are too high. It evaluates various process improvement methodologies and selects an approach based on Six Sigma. It methodically analyzes the steps involved in order processing, warehouse picking, and customer returns to determine the sources of costly exceptions. It designs standard process flowcharts to reduce variations and implements order minimums and other policy changes to reduce exceptions.
As a result, exceptions go down, but so do orders. Many customers stop buying anything from the distributor because they no longer have the option of returning the one item they are not sure about.
These examples show both the appeal and the risk of the best practices approach. It is often much easier to buy material handling equipment or send staff to a training class than to grapple with strategic questions. But the reality is that the very concept of best practices requires a strategic context.
If your company is pursuing a price leadership (operational excellence) strategy, then Six Sigma is potentially a very powerful tool, as it can help you drive cost-killing variations out of your processes. In contrast, if you are using a customer intimacy approach, variations are at the very heart of your value proposition. Whether or not Six Sigma is statistically correlated with superior financial performance in general, it is likely to be poisonous to your particular business.
By starting with a solution instead of a diagnosis, the best practices approach can also fail to address root causes. It is usually very difficult to drill down from an income statement or balance sheet to a specific process deficiency. Consider, for example, the simple measurement of inventory turns.
Most distributors must carry a mix of fast- and slower-moving items to satisfy their customers. Poor inventory turnover could indicate a preponderance of dead stock, potentially caused by poor forecasting or overbuying to get better pricing from suppliers. However, it could equally mean that your supply chain is unable to meet demand for higher-moving items, thus reducing the portion of high movers in the average figure for assets. The solution to the former problem (buy less) is diametrically different from the solution to the latter (buy more).
Strategy First Successes
Creating a clear and compelling link between a project and a company’s market strategy certainly does not guarantee its success. But examples from our research show that good linkage helps to ensure that the initiative addresses critical issues and opportunities.
An industrial distributor in the Southwest faces an insurmountable disadvantage against national competitors in serving Fortune 500 companies. Local plants are moving a growing portion of their spend to negotiated contracts, which are tendered at the corporate level, typically outside of the distributor’s sales area.
The sales force is adept at providing a high level of customized services tailored to unique customer situations. This skill does not protect them from losing business to national agreements, so they decide to re-evaluate the market.
As a result, the distributor redefines its target customer as a plant that is not a division of a Fortune 500 firm (so they will not lose the local relationship to a top-down corporate deal) and has poor supply chain management skills (so they value the heroic recovery capabilities of a local sales rep).
After the distributor determines that the size of this customer base is more than sufficient to meet its long-term growth objectives, it proactively retasks its sales force to focus solely on these customers by using performance measurement tools and compensation plans. The result is a slightly lower growth rate, but higher margins. More importantly, the distributor ends the risk of losing a major revenue stream due to events beyond its control. The company continues to sell to Fortune 500 plants, but at higher margins.
A building products distributor analyzes the economics of its lumber yard customers. It determines that because those customers focus on merchandizing more than buying, they place a high value on distributor bundling. That is, the ability to buy a broad range of items from a single supplier to reduce the time, complexity, and cost involved in purchasing.
The distributor also concludes that the yards have very little economic incentive to seek exceptions to builder specifications. Based on these insights, the distributor redeploys its sales force from calling on lumber yards to calling on builders. The intention is to induce builders to specify a marquee brand of windows the distributor carries. Since the company is the only supplier in the market that offers both a broad range of building supplies and the specified window, the strategy works brilliantly. The distributor’s growth rate is four times the average of its competitors.
A heating, ventilation, and air conditioning (HVAC) equipment distributor in a rural area recognizes that the low sales density of its territory represents an opportunity. Its core contractor customers highly value local inventory because they are typically generalists who cannot predict what they will be working on tomorrow.
Since the cost of stocking inventory at a branch is largely driven by transportation, the distributor analyzes its logistics processes. It concludes that the best way to lower cost enough to justify local inventory is to deliver only full truckloads to the branches from a distribution center.
But to do so while maintaining daily deliveries, the distributor realizes that it must sell twice as much of something every day. It embarks on an intensive program to build sales volume at branches by offering a wider range of relevant products, including electrical supplies, tools, and consumables. It also drops prices of its core HVAC products to stimulate demand, expands branch opening hours, and actively markets to consumers. Competitors are driven out of some smaller markets completely.
The key was for the distributor to let go of some long-held assumptions about its core competency (its HVAC expertise) and financial performance metrics (gross margin percent, for example).
A specialty components distributor exploits a niche market by supplying military-grade components to airframe manufacturers and other risk-obsessed customers. It has aligned its entire organization to meet their unique needs, creating a robust barrier to competitors. Procurement and warehousing operations are ISO-certified, with strict procedures for quality inspection, lot tracking, and documentation control. Sales reps have technical backgrounds and are fluent in the language of “engineering change orders,” military specifications, and cost-of-failure calculations. This company would never have achieved its great success by following the standard wholesaler-distributor efficiency cookbook.
A small oil and gas products distributor wants to expand geographically, but chooses to open in smaller markets instead of large cities. They recognize that in smaller towns there is a stronger desire to support local business. By hiring local staff from competitors, they acquire local relationships.
By staying under the competitive radar screen, the company is able to generate solid growth at higher margins. This model creates a strong market position in a short period of time and the company is acquired for a large multiple by a consolidator. Part of the premium was due to the lack of customer overlap.
These examples share a similar methodology. The first step is determining strategic priorities based on a genuine understanding of customers’ economic drivers. Next, identify the critical few elements for success. Finally, align the company behind these necessary changes.
Few executives interviewed for this book explained their approach to us in these terms. From their market-driven perspective, they simply sensed a need in the market and reacted forcefully.
Every company has a limited number of employees to devote to improvement projects, limited financial resources, and limited executive bandwidth. Any investment in noncritical areas represents an investment that is not made in critical areas. The strategic approach is the best method that we have found for identifying those few critical areas.