The bittersweet sting of reality.
Salesperson 1: “Score, just got 50% GP on that ticket!”
Salesperson 2: “Nice work, that sounds like a real money-maker to me!”
Reality: 50% GP on a bag of cable ties scheduled for next-day delivery, guaranteed before noon, likely doesn’t even cover the cost of the warehouse pick … not to mention the cost of all other SG&A expenses that a distributor naturally incurs. And to top it all off, no delivery fee was charged!
Although the above is an extreme example, I have seen this firsthand and have also heard similar horror stories from many other industry veterans. In fact, I am quite confident that many of you reading this had a quick chuckle as you were unfortunately able to relate to such a scenario at one point or another in your career.
For the traditional distributor, it is a well-known fact that small orders have a low probability of netting bottom-line dollars. It is largely economically unfeasible for them to do so unless you have tremendous scale, optimized supporting infrastructure and cutting-edge technology, like Amazon does.
But even they struggle to turn a predictable profit on these smaller transactions on a consistent basis. As proof, consider that they have subsequently deployed a type of strategic Minimum Order Size Policy: “add-on” items.
These are SKUs that are only available for purchase with over $25 of items shipped by Amazon to the same address because shipping them by themselves would be “cost-prohibitive.”
Many would argue that Amazon has no minimum order size policy, but it is plain as day that they do; it is just very strategic and selective in its application.
So, at what point did wholesaler-distributors begin to accept low-volume, high-mark-up “7-Eleven” convenience-store type orders? Should we strive to make money on every single transaction? Is it even possible to do so?
When Does a Published Minimum Order Size Policy Make Sense?
The short and sweet answer: It depends. And it depends on many factors. But first, there must be a benefit for such a policy to exist.
Given the growing prevalence of cost-to-serve analytics, “minimums” are currently a trending topic in the industry. For the sake of clarity, this article is about setting a floor for the entirety of a given transaction (minimum order size or MOS) instead of establishing base-line thresholds for a specific item’s unit of measure (minimum order quantity or MOQ).
Simply stated, an MOS would require that you spend $25 in total no matter what you buy, while MOQ would require that, if you want to buy Q-tips, you have to buy at least a box (you can’t buy just one Q-tip).
In this sense, MOQ is far more granular in approach and can actually be considered one of the actionable levers used to support an MOS. Alternatively, you can certainly implement an MOQ independently of an MOS, but a strategic use of both can be quite impactful.
For those distributors who are actively assessing and leveraging “what good looks like,” and doing so with supporting data rather than relying on long-held cherished beliefs, a segmented Minimum Order Size (MOS) policy may be what the doctor ordered. If planned and executed correctly, you can almost immediately drive additional basis points to your bottom line.
The catch here is that the policy is used as a lever to support a greater customer segmentation strategy effort. An important distinction is that an MOS policy is just as much about who gets to break the rule as it is about who must follow the rule.
For instance, taking small orders can mean the difference between turning a targeted small but growing account into your next large cash cow or leaving them with a bad experience and a solid reason in hand to buy from your competition instead. In the words of industry veteran Bruce Merrifield, we know not every acorn turns into a giant oak tree, but certainly some do.
Another clear example would be keeping your current golden-goose customer happy when they get into a bind. Picture this: Your largest and most profitable account is in dire need of the cable ties from the introductory example.
What do you do? No one in their right mind would tell them, “Sorry, we are not able to sell you that as it does not meet our minimum order policy.” You’d get them that material pronto, no questions asked and without hesitation.
On the other hand, continually allowing any customer to place low-dollar orders, regardless of their current or potential value to the distributor can lead to the death-by-a-thousand-cuts saga. In this scenario, a distributor’s finite resources are consistently being consumed by suboptimal opportunities, thereby limiting total earnings and growth potential.
Typically, we see this scenario occurring at a distributorship that has not yet accepted the fact that not all customers, nor gross margin dollars, are created equal. This may sound harsh, but it is a fact-based and true statement.
Should you happen to disagree, then it is certainly possible that for you, “what good looks like” may not be appropriately aligned with reality. If you do a quick self-analysis and discover that you treat all customers, orders and opportunities the same, then implementing an MOS policy could be a negative move.
Without first doing a deeper dive into collecting and analyzing data that would lead to some level of basic customer segmentation, an MOS policy would be ill-advised.
What is Driving Small Orders?
After you’ve decided that a benefit exists to having such a policy, identify the reason that small orders are a problem and know the contributing factors based on supporting data. In general, factors manifest as a result of either the customer, the distributor or both.
Customer ordering behaviors and needs vary by geography, industry and size, as well as by business model and infrastructure, just as selling and fulfillment characteristics do for a distributor.
No matter which side of the customer segmentation fence you fall on, you must look both internally and externally when analyzing the impact of small orders within your business.
Though there is no shortage of customers who have less-than-stellar buying behaviors, we often discover that a large portion of small orders are caused by distributor-controlled sales or supply chain functions and behaviors.
For sales, think reactive order takers (market-serving) rather than proactive sellers and up/cross-sellers (market-making). For supply chain, think backorders due to suboptimal inventory levels, automated-but-forgotten-and-not-monitored ERP processes, and distributor-controlled high-turn low-dollar integrated supply/VMI relationships.
Instituting an MOS in scenarios where the problem is distributor-induced would be the wrong move, or at least a higher-risk one, as customers would be forced to pay for inefficiencies that are not necessarily within their control or purview.
It is critically important to recognize the causality and distinction between orders and invoices. Typically, order characteristics and frequency have greater potential to be customer-induced, while invoices are more heavily influenced by the distributor.
When Is a Good Time to Implement a Minimum Order Size Policy?
You must be willing to endure the challenges as well as have an appetite for the risk/reward. You must also be able to clearly answer “why” as it relates to an MOS Policy and do so with conviction.
Change is hard and “no one likes change except a wet baby” (a special thanks to Mike Marks for etching this memorable quote into my change-management repertoire).
As supporting evidence, regardless of the severity of the proposed change, people will typically say something like, “Now is not the best time” or, “Don’t we have enough going on already?”
But this is especially true when the change can have vast sweeping effects and will likely force customer-facing team members into awkward or uncomfortable situations.
Specifically, telling salespeople that they have to have tough conversations with customers where the perceived benefit is skewed to the distributor (despite their being a real economic benefit for many customers as well!) usually goes over like a lead balloon:
“I’m sorry, your order currently doesn’t meet our minimum. Are there other items that you need at this time? If not, I’ll have to charge you a special handling fee instead to meet the minimum.”
Though very diplomatic and professional, such a response from your sales team can and will elicit a wide variety of customer reactions, some of which can be quite entertaining. This is why we insist that the policy must be applied selectively and aligned with a greater customer segmentation strategy.
More than a Stand-Alone Plan
Without being part of a bigger vision, an MOS policy is far less likely to succeed. As a standalone initiative, it is often insurmountable to attain internal buy-in, effectively rendering it unenforceable and therefore moot.
When an MOS policy is a piece of the greater puzzle, it will shape the purpose, message and execution for your team and customers. This will help distributors avoid the commonly experienced landmines that many companies step on when implementing order minimums.
Recall the tough conversation above and estimate how long it will be until your own team does not enforce the minimum just to avoid awkward conversations if they do not understand or agree with the “why” of the policy.
If the MOS policy is clearly a lever in strategy implementation, you must also define the relevant goal.
As an example, is the focus of the policy to increase fee-based income or is it to try and drive an increased share of customer wallet? Could it also be to improve customer awareness around their Total Cost of Ownership?
Your answer to this piece will have implications that ripple throughout the process of both MOS policy design and execution.
In addition, give careful consideration to the possible impacts on the short- and long-term performance metrics.
You should be keenly aware that the makeup and characteristics of your customers that are subject to the policy will have a significant impact on both the up and downside potential.
The proforma analysis also needs to incorporate the impact on customer spend: For some customers, they won’t even notice as it may never apply to them, whereas others may be impacted greatly and on a regular basis enough to drive them away from you being their supplier.
Before moving forward with an MOS policy, you should be able to answer at least three questions:
- What is the strategy that this is helping to execute?
- What is the policy’s driving focus?
- What is the risk/reward factor?
For a relatively quick, back-of-the-napkin estimate of the potential impact of an MOS to your company, gather the order transaction history from your ERP for a defined time period. I suggest looking at the most recent fiscal year or YTD. Have the report list unique orders and their associated dollar values on each row.
Next, pick a minimum-order amount for the policy and count the number of transactions that fall below that threshold.
Depending on the policy mechanism, you can either multiply the resulting quantity by a small-order fee in an amount of your choosing, or you can sum all occurrences of the difference between the minimum order value that you chose and the actual order values in the report.
Either approach will produce a ballpark-maximum estimate for the drop-through potential that an MOS policy can have on your bottom line.
If you want to increase the degree of accuracy, you can exclude orders from customers that would be exempt from the policy and even throw in a “lost sale” component to compensate for those customers who would rather walk away than be subject to an MOS policy. By no means is this approach exact, but it can at least help you determine whether you are dealing with a grape or a watermelon when trying to determine if the juice is worth the squeeze.
McKinnon Shisko joined Indian River Consulting Group in 2019 as senior associate consultant. Shisko leverages his diverse experience and wide range of expertise to help organizations and teams effectively and efficiently achieve their desired results. Contact him at email@example.com or visit ircg.com.