Are we ‘normal’ or just accustomed to strange ways?
Let’s look at the specifics
BY RICH SCHMITT
Management specialist
Having just finished the holidays, we are all probably reminded that our family is a great part of our lives and that we all need to spend more time with them. As they say, “Life is too short and then you die.” Maybe it is just me but it seemed like we lost a lot of good people from our industry in 2011 and, I know that I didn’t do a good job of thanking them for their contribution to my life. In 2012, one of my personal resolutions is to take a little time to thank those who were so generous with their time and knowledge in my career.
Through the holiday gatherings, many of us are also reminded that some of our families (of course, not mine or yours) are more like the Simpsons than the “Leave-it-to-Beaver” Cleavers. Using the word dysfunctional may be an understatement. I sometimes wonder if Jerry Springer and reality TV are shaping the new norm for how families act and relate or don’t relate. Or maybe it is just showing us who we really are without all the politically correct filtering. As I discussed reducing the drama in our lives last month it also occurred to me that we may have become desensitized to the drama creators. (Maybe to the point that we just assume that they are normal and that nothing can or should be done.)
With the questions in the back of my head about what is a normal family and becoming desensitized to the drama creators, I began to wonder, “What is normal in hard-goods distribution?” Are we on course or have we just become accustomed to a goofy existence? In a previous column, I discussed the “Economic New Normal” that we are operating in but I am thinking about the basics and the fundamentals of what we do. With apologies to the industry academics, this will be a Rich’s Business 101 version of how I understand it to work.
There are specific functions or tasks that must be performed in order to sell products to the installer. Those functions can be provided in a variety of ways but seemingly they cannot be eliminated without causing a hitch in the process. Typically the functions are:
1. Manufacturing — making the product
2. Marketing/Selling to the installer — promoting/soliciting business for the products to be sold
3. Getting the product to the installer — Inventorying and delivering
4. Financial portion of the transaction — providing credit to the installer, billing the installer, collecting from the installer
5. Support — technical & warranty support to the installer
While there are many ways to accomplish each function, seemingly all functions must be performed by someone. Much of the product moved in our industry is through wholesalers or distributors so the execution of these required functions is typically shared between the manufacturer and the wholesaler.
Manufacturers
Often shown at the top of the channel diagram. In most cases, the manufacturers produce goods in one or more locations. Often manufacturing operations must be configured specifically to produce certain products. (As the state of the art evolves, factories are designed to be more flexible but in hard-goods, a production line is often configured to make a single product or family of products that have relatively small differences.) Since this production line reconfiguration is often quite involved and requires that the operation or sometimes the entire factory be shut down while a product changeover is done, the factory does large runs of products for the sake of efficiency.
Some factories may build a specific product only once or a couple times per year. If they do one run, they need to produce a full year’s supply of the product during that run. So if the forecast demand for the product is 10,000, the factory will build 10,000 items then reconfigure the line or factory to build the next product on their production schedule. If the factory is located in St. Louis, the manufacturer has a warehouse full of the product in St. Louis. If this product is to be sold nationally, it is centrally located but far from customers on both coasts. Most manufacturers cannot afford warehousing to store a full year’s inventory of all their products. Thus they need to move most of the 10,000 out of the warehouse so there is room for the next product on their production schedule.
The manufacturer typically has two options:
1. Sell direct — therefore taking responsibility for all functions in the channel. This does not involve a wholesaler. In our industry some manufacturers seem to cycle between performing these functions and using wholesalers. They get frustrated with their wholesaler’s performance and their (the manufacturer’s) lack of control. (Plus some have the misguided view that wholesaling is easy.) So after 4-5 years they cycle back out of distribution having rediscovered that wholesaling is a difficult, messy, complex business.
a. Inventory — All product is stored in their St. Louis warehouse or manufacturers build or lease regional warehouses to move product closer to the customer. Since most installers do not have room to inventory much product, the manufacturer is forced to have warehouse space for their entire inventory.
b. Delivery —
• All product is shipped directly to the installer: Most manufacturers are configured to ship truckloads of product not a single toilet to Bob the Plumber in Portland, Maine or Tom the Plumber in Portland, Oregon. The infrastructure required to ship single products is expensive and very labor intensive.
• Local/regional warehouses could be used — while this might work in a major metro area, few manufacturers have sufficient volume in smaller markets to warehouse product there.
c. Selling — There is also the hassle of selling products to Bob and Tom using a factory sales team or rep agencies.
Staffing a national sales force to sell to plumbers across the country is a costly and management intensive effort.
d. Credit/collections — The transaction could be paid using a credit card but traditionally buying “on account” is expected by trade customers which adds a national credit and collections group into the manufacturer’s team.
e. Customer support/warranty — This would require a national customer support organization to handle problems and warranty claims.
2. Sell through local, regional or national distributors/wholesalers
a. The above functions are similar except typically there is a local presence and local execution of most of the functions.
b. The other main difference is that the local presence is affordable since wholesalers sell products from multiple manufacturers and thus enjoy some economies of scale. In effect, hundreds of manufacturers have micro-operations within a wholesaler.
c. While the economy of scale is positive, the inefficiencies and difficulties of managing and making money selling tens of thousands of products from hundreds of manufacturers is a huge challenge.
d. The responsibility and cost of each function is moved to the wholesaler and so there must be sufficient margin to cover the cost of those functions and to make a profit.
e. Successful wholesalers understand and manage their costs for providing each function and they remove any function that the installer doesn’t value…in other words, is not willing to pay for.
f. Obviously the manufacturer must now execute the same functions with the wholesalers but on a much smaller scale so adding a “step” into the channel involves some additional cost to the channel.
While this is very simplified, that’s how I think it’s supposed to work “in theory.” As someone observed, “I wish I lived in Theory because everything seems to work in Theory but certainly not where I live.”
So let’s assume we’re talking about distribution through a wholesaler and discuss some of the challenges that can make the channel dysfunctional.
1. The wholesaler doesn’t sell — As I have discussed before, during the boom times we all got out of practice when it comes to selling. We naturally thought that customers were arriving in hoards due to our brilliant wit, our great charm and, of course, our good looks. When, in fact, they just needed product. (BTW, I don’t want to live in Fact because the truth often hurts.) When the tough times hit, it was hard to change our ways. In the good times, the manufacturers tolerated this default selling because business was very good. Now manufacturers are viewing some of their non-selling wholesalers as more of a roadblock than the express lane to the installer. (Manufacturers sometimes perceive non-selling wholesalers to be lazy or disinterested.)
2. The wholesaler doesn’t properly sell all of his lines — Part of the wholesaler’s obligation to the manufacturer is to actively sell the lines that he is given. This starts with the development and ongoing maintenance of the wholesaler’s “stocking list.” When wholesalers don’t take this seriously, they increase their costs and defocus their team. It is critical that the wholesaler periodically assess each item on the stocking list very carefully.
a. Does the wholesaler have the ability to stock the product?
• Financially — Is there enough money to inventory the product in quantities so the customer can count on the wholesaler to provide the product reliably?
• Physically — Is there enough warehouse space to stock an adequate quantity of the product so the customer can count on the wholesaler to provide the product reliably?
If the wholesaler cannot be reliable they are often not considered to be day-in, day-out source for the product.
b. Can the wholesaler sell the product?
• Marketing and promotion — Will there be sufficient time and dollars to market the product? Few products in our industry sell themselves. At the very least, trade customers should know that the wholesaler stocks the product. Even better, there should be activities to entice the customer to try or to use each product.
• Sales time — Is there enough sales capacity to sell the product on an ongoing basis?
• Sales push — Can the sales team go into “hyper-drive” to properly introduce new products or changes to the product to the customers?
• Sales commitment — Is there a signed-in-blood-quota for the team that documents their promise to sell the product?
3. The manufacturer sets pricing in the local market. This happens in a variety of ways —
a. The manufacturer publishes a list price sheet — If there was a single action that I would recommend to manufacturers to help wholesalers it would be to stop creating list price sheets. They restrict the wholesalers’ ability to make money.
• Top performing wholesalers vary the margin based upon each product’s price sensitivity, its velocity, its shrinkage and availability to create fine-tuned, micro-managed pricing that will provide the optimum profit output.
• Some wholesalers use list and a single discount across whole lines of product. One wholesaler characterized it this way, “The lazy wholesalers use list and discount to mess up the market for everyone. Some of it got sorted out in the last downturn but there are still plenty of these ‘worst practice’ wholesalers out there. Manufacturers ‘enable’ this practice when they publish list pricesheets. What I find offensive is that the practice is there to support the manufacturers’ worst wholesalers, not those of u working hard to make money.”
• The wholesaler needs to know his cost and then to use that cost to set a thoughtful, competitive, profitable, market-based price for each product sold to their customers in their area.
When I have discussed this directly with manufacturers’ senior manager, there have generally been two lame excuses: 1) I agree it’s dumb but it’s the way we have always done it. 2) Our wholesalers are lazy and they demand it.
b. A rep makes price suggestions to trade customers: Reps have a very important role in promoting products but suggesting product pricing to trade customers is not, in my opinion, any part of that role. Sharing pricing with trade customers, in effect, defines an expected market price without regard to the wholesalers’ cost of stocking and supporting the product. This then prevents wholesalers from creating thoughtful, competitive, profitable, market-based prices for each product
As I said before, there are certain functions that must be performed to make the channel work. There are a myriad of ways to divide those functions between the manufacturer and the wholesaler. The dysfunctions seem to occur when each party thinks the other has the ball, thus nobody has the ball, somebody fumbles the ball or either party “phones in” their effort when they have the ball. I think the first task is to understand the roles, responsibilities and rewards in the channel so we can do more of the right things and less of the wrong things as we conduct business. This, “in Theory” should make you more money.
As a head start on my 2012 resolution, I’d like to thank all the folks at The Wholesaler who do the heavy lifting in publishing the best magazine in our industry. (I am opinionated of course.) Special thanks to publisher Tom Brown, production manager Cate Brown, managing editor Jim Schaible, editorial director Mary Jo Martin, and of course my father Joe (posthumously) who generously mentored me when I started co-writing this column with him a little over 16 years ago.
Rich Schmitt is president of Schmitt Consulting Group Inc., a management consulting firm focused on improving the profitability of distribution and manufacturing clients. Rich is also the co-owner of Schmitt ProfitTools Inc. (SPI), a business producing print, CD-ROM, web and palm-based catalogs as well as pricing management and analysis software for wholesalers. Go to www.go-spi.com for more information.