Article 3.10

 

INFORMATION INTO KNOWLEDGE[1]

CASE #2: MEASURING FOR MARGIN POWER

 

            If either a distribution firm or its association's financial survey wanted to measure factors that support an above average margin percent, what should be measured? Although there may not be a universal solution to this question for all distribution channels, with the right assumptions and measurements we could start down a productive, learning path.

 

DO PREMIUM MARGINS EXIST?

            Service management research concludes that firms with superior service levels achieve price premiums that average 5-10% of their average competitors' gross margin. By example, if an “average” distributor was achieving a 20% margin rate, then superior service should be able to earn a 21-22% margin rate on the same sales mix. This extra margin would increase the average distributor's operating income by 50 to 100%!

 

            A number of association financial surveys offer indirect proof that service premiums are possible within the distribution industry. A recent example can be taken from the Air-Conditioning and Refrigeration Wholesale Assn.'s (ARW) “1994 Profit Report”[2]. The average firm in the survey earned a margin percent of 27.5%, but the top 25% performers on an ROI basis averaged 29.4% for a 6.9% premium. Because the top performers were a bit smaller in sales than the average firm, we might assume that the premium didn't come from buying better, but from selling “distinctive service.” But, what exactly is “distinctive?”

 

            In one sense, it is a competition-relative standard. Using a scale of 1 to 5 for service quality in a survey of customers, if “1” was considered poor, “3” average for a group of possible suppliers, and “4” better than most, then 4.5+ is “distinctiveWell-run service firms can evolve to a score of 4 in their customers' eyes, and this will earn them last-look to meet the price. To get to a 4.5+ score, however, all employees must proactively work together to rethink the service processes, their jobs and commitment levels.

 

            In an absolute sense, all distributors face the FedEx service standard comparison. If any distributor were to offer a “zero error and 100% on time unconditional guarantee,” coupled with equal or better fill-rates, then they would have “distinctive service

 

THE SUB-ELEMENTS OF “DISTINCTIVE SERVICE”

            Because customers decide who has the best service and how much more they might pay for it, we should survey our target customers about “service We could give them a list of every service factor and ask them to rank the elements on a value scale from 100 (most valuable) to zero.

 

            Remembering that today's best customer is typically a large, experienced, repeat buyer of the commodities that comprise 80 to 95% of a distributor's sales, the following priority list represents a consensus of a number of private surveys:

 

 

Article 3.10

 

1. highest fill-rates on a one-stop-shop of items

2. zero errors on order execution

3. on-time delivery (assuming desired response time)

4. heroic recoveries for service failures

5. price and terms

6. quality of the inside sales service

7. quality of the outside sales service

 

            “Best price and terms” logically trails items numbered 1 to 4, because what good are price savings if they are exceeded by the costs of poor service. Ninety percent of distributors who are not in the top decile for service performance might contend that “price” should be ranked higher. But, we must remember that if we are undifferentiated on the top four service factors, then “price” for equally excellent commodities becomes #1.

 

            The role and value of the outside and inside salespeople in achieving margin premiums is crucial and problematic. Annual big buyer surveys are concluding that “90% of the salesreps are a waste of time.”[3] This is reflected in the #7 rating for “salesrep value”, down from #1 in 1970 for many reasons. If we want to sell service for a premium, we would do best with the top decile reps whom buyers think are worthwhile. Excellent reps can sell both their own value-added efforts and the company's basic service brilliance for incremental premiums. We don't need reps that would consider themselves a success for getting “last-look with a chance to meet the price” when the customer is really buying the 4.0+ service quality generated by items numbered 1-6.

           

MEASURING FOR SERVICE IMPROVEMENT

            Individual firms should invest in creating an internal scoring system for all employees which balances some traditional financial goals with service quality trendlines. Then, experiments can be run to discover ways to improve service levels while also lowering costs and improving margins.

 

            Association financial surveys could start complementing their strong financial formats with some first approximation measurements for service quality. For example: “dollars invested per stock keeping unit” would reflect fillrate levels. Do the “high performers” average greater dollars per item?

 

            For zero errors and on-time delivery, several ratios might provide insight. “Credits issued annually divided by transactions” is easily available data for most survey participants. When there are errors, credits are usually issued. Don't be surprised if the best average a significantly lower ratio.

 

            Low errors and high on-time delivery rates occur at warehouses that usually pay high wages to warehouse and driving personnel; FedEx and UPS do this. If we pay the most, we can hire the best; expect the most; and have the lowest turnover rates. The longer these service critical folks stay, the better service becomes, especially if we measure and seek to improve it.

 

            This service investment strategy also yields a lower “personnel productivity ratio (PPR)Although wages are higher per person, fewer, better folks who don't make mistakes, turnover or need supervisory babysitting can support an even greater increase in the margin dollar per employee ratio. The ratio of employee costs to margin dollars is therefore lower than the industry average.

 

            For “heroic recoveries” ask survey participants how much any frontline person can spend if they come in first contact with a mis-serviced customer. The Ritz-Carlton Hotel chain, for example, authorizes their maids, etc. to spend up to $2000 to make any customer happy.

 

FINAL THOUGHTS

            If a distribution business is going after full-service customer niche(s), better than average margins are possible with “distinctive serviceThe incremental margin flows mostly to the bottom line, which is only part of the economic benefit. Excellent service also improves: employee morale and retention; customer satisfaction, retention and word-of-mouth; and the company's growth rate.

 

            To achieve “distinctive service” we need to spend less time managing financial symptoms in a top down way and more time developing bottom-up measuring systems that are focused on the sources of profit power. Then, all of the financial symptoms can improve dramatically as a byproduct phenomenon.

 

            This switch to a more balanced scorekeeping approach can be sparked by adding the service quality perspective to association financial surveys. As a first cut, if surveys found high correlations between “high performance” and some of the crude service ratios previously mentioned, then average performers might take notice. More service-quality questions, theories and experimental requests might subsequently be made. Pursuing these fresh insights could then lead down a more fruitful path than reformatting the same old financial data.

 

 

 

 

Merrifield Consulting Group, Inc., Article # 3.10



[1]“Information into Knowledge” is a reference to a four step model: “data information knowledge wisdom.” This model is reviewed  in Distribution Opportunity Essay # 7, and in great detail in the book.

The Monster Under The Bed by Stan Davis and Jim Botkin.

[2]ARW’s Report was ably produced by The Profit Planning Group of Boulder, CO.

[3]For example, The National Association of Purchasing Managers (NAPM) annual “Big Buyer Survey” supports to 90% statistic.