Consultative selling and product push have run their course. It’s time to look at a new distribution service model.

by Scott Benfield

Since inception, distributors have developed a business model that is primarily product push. The hypothesis is that wholesalers have relied on product knowledge and outside sales as the primary methods to market. This made sense in the beginning of the industry life cycle. Manufacturers developed new products at a fast rate and product knowledgeable sellers relayed the changing body of knowledge to customers.

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This model, however, lost its steam somewhere in the last 20 years. Why? Basically, products have matured until there are only a handful of vendors left in most product categories. Today, product development is marked by incremental improvements to old platforms. Buyers are more knowledgeable about the products they need because they have a buying history and because of a lack of breakthrough technologies.

Not all products and sellers are in this quandary, of course. But the theory in general is valid. The question is, what should wholesalers do to combat a mature industry/low margin spiral?

Not all distributors agree with the preceding paragraphs. Many industrial distributors make a good living with their stock-in-trade being product knowledge and talented outside sellers. Looking at the overall trend, however, the picture for industrial wholesalers is worrisome.

Between 1989 and 1999, net profit before taxes fell from 1.9 percent to 1.7 percent, while operating expenses fell from 22.3 percent to 19.4 percent (Source: Industrial Distribution Association). If this isn’t alarming, then consider that return on assets went from an average of 7.68 percent in 1997 to 6.9 percent in 1998, and 6.75 percent in 1999. Net profit as a percent of net worth is somewhere around 12 percent to 13 percent.

At these profit levels, many distributor owners could get comparable returns by investing in an index fund, with the added bonuses of diversification and liquidity. Some distribution owners may argue that they also take personal compensation out of the business. Their defense is poorly phrased. Why? Because what’s meaningful is the difference in compensation received from the business and comparable compensation received from outside the business. If the gap between what the owner pays himself vs. what he could get paid on the outside is small, then holding on to a downward spiraling entity becomes less attractive. The hard question that befuddles industry insiders is why — in one of the best economic periods of modern times — have industrial distributors’ profits shrunk as a percent of sales?

There probably is no smoking gun that is convenient to point to. But there is ample evidence supporting the idea that the product push model has outlived its usefulness and should be replaced with a newer, more appropriate model.

The Service Fee Model
The financial performance of industrial distributors is moving down in an upward moving economy. The plethora of consultants and schools of distribution, if they have the answers, aren’t being listened to and wholesaler top management appears more willing to switch (sell out) than fight.

As shown in Figure 1 below, the first area of major change will be away from a product driven/ product knowledge organization. In the Service Fee Model, only the newest and most promising products deserve attention. Product managers (not sellers) coordinate product reviews and launches with manufacturers.

The most prevalent need is for good service research and measurement. Instruments include satisfaction research, service attribute mapping, new service development and, in general, a call for service marketing. Most sellers won’t make the grade on these disciplines. Professional marketers will earn top dollars from the larger, more progressive companies. Distributors must move away from manufacturer supplied differentiation, to differentiation by unique services funded from the distributor’s marketing funds.

Pricing control is a major barrier to transitioning to a service fee organization. Pricing will move from a product-based model to a model that uses list and discount pricing by market segment for products and value-based pricing for services. Sellers will be removed from cost-plus pricing except for fluctuating commodities and given strict guidelines on discount ranges. Marketing and finance will control pricing and plan annual pricing increases to add to the profit plan. Higher value-added and new services will be unbundled from products and priced separately. Sellers won’t control these pricing schemes. It will be up to marketing to develop and police them.

Sales promotion for products will all but disappear. Market demand is not influenced by “buy this, get that” promotional gimmicks and distributors are beginning to realize that these efforts attract the price sensitive buyer. The promotion driven customer moves to the next deal when the promotion is over.

Inside sellers need well-designed and smartly developed incentives to sell service offerings. Inside sellers will be pressured to align service needs with customer expectations. Marketing will develop matrices for service pricing by market segment.

Outside sellers, usually the most talented, will be trimmed to allow for more inside sellers/account representatives. Sellers who remain outside will focus on key accounts, relationship management, new technologies, or complex products. Consultative selling will be left for the best customers or those willing to pay for the consultation. The compensation gap between inside and outside sellers will narrow.

If you are bound and determined to hang on to your valuable outside sellers, consider the following: service researchers have noticed that outside sales is last on the list of attributes to maintain service satisfaction. If you wonder about the value of outside sellers to the customer, determine their cost- per-call and give the customer the choice of a sales call or a comparable discount on the next order. There is no longer time to fund 3 percent to 5 percent of revenues for sellers who are not productive. The industrial distribution platform, if not burning, is smoking and cost will come out before owners trim their personal return.

Compensation will focus on earnings instead of top-line or gross margin dollar growth. Currently, most sales managers reward on gross margin dollars. This is nominally better than top-line growth reward systems. Sellers who control price reduce prices in order to reach margin dollar or sales dollar goals. Unfortunately, these reward systems don’t measure the operating expenses to serve customers and price cutting can accelerate the decreasing profit spiral. Also, remember that cutting price by 1 percent in a 21 percent gross margin business takes a 5 percent increase on the top line to break even. Compensation systems should reward on both gross margins and gross margin percent, on activity profits, or simply on net profits.

Accounting systems must become more robust and accountants must develop hurdle rates for investments and advise accordingly. Currently, accounting systems are very conservative. Many distributors don’t have rolling financial statements to gauge progress during the year. Even more lack a robust chart of accounts that allows good budget management and expense allocation. Beyond traditional accounting, many wholesalers still haven’t adopted an activity-based costing (ABC) system even though the call has been out for many years. I have taken the position that I would not touch an integrated supply or large vendor-managed inventory agreement without ABC measurement since the activity margins on many are negative. Distributors that persist in not adopting activity costing force management into accepting managed inventory agreements that are not long-term profitable investments.

Lastly, distributors should take a serious look at professional marketing. Many marketers in distribution are former sellers with a marketing title. While the marketer has tenure within and knowledge of the industry, they often don’t possess up-to-date skills in service marketing, statistical research, advanced financial measurement, and cross-functional planning. These skills can be learned but are quite different from those found at the sales level. Review Figure 2 in light of your current marketer and decide which skill sets he or she has.

Don’t expect a seller to turn marketer overnight. Distribution management has put far more money into sellers than marketers and, unfortunately, the sales product push no longer works. Many distributors still don’t have a meaningful segment strategy, pricing systems are too loose and not strategic, and service measurement and management is sporadic.

Hiring a professional marketer takes planning and money. The marketer should have a service and product background. They should have enough clout to change the sales culture and, if need be, break it.

I recently talked to an industrial distributor that hired a professional marketer after unsuccessfully trying three sellers turned marketer. Six months later, things were much better and the outlook was good. Unfortunately, the marketer had to break the sales culture and hire marketers from outside to do the work. This was a large company with outside investors whose patience had grown thin because of low earnings. The marketer was building a department from the ground up.

Marketing research, segment marketing, and the marketing communications position was sourced from the outside.

There is a world of opportunity to further develop marketing, including service product development, matching operations to segment expectations, and developing pricing management that maximizes profits but doesn’t scare off the best customers.

The time for rationalization is drawing to a close. Financial performance points to a radically different way of management. Trying to change incrementally, in my opinion, just won’t cut it. Some people are listening and taking action. The company mentioned previously is one of two large industrial distributors that have hired professional marketers and is attempting to build a marketing-driven culture. A large consortium is attempting to establish service fees for managed agreements.

Last, but not least, if distributors serve customers who aren’t willing to pay for the service, they have two options. They can either remove services that aren’t customer-sensitive or simply walk away from the business.

Time is against industrial distributors unless a miraculous trend appears that is opposite the experience of recent years. I don’t put much faith in miracle results. To change in a big way, you have to make big changes.