August 18, 2017


















Article 8.17

ATTACK YOUR CROSS-SUBSIDIES NOW

Most manufacturers and distributors have large cross-subsidies that exist within their traditional business models. Twenty percent of the customers that buy large, repeat orders of mature, faster moving items in a routine way followed by prompt pay generate about 150% of the average firmís profits. The extra 50% is spent, however, subsidizing the customers that are small, new, ignorant, poor paying, and/or growing nowhere; small orders of all kinds; slow to non-moving items; and all prospective selling initiatives that donít pan out.

Internet commerce applications will soon expose and liquidate the subsidies, but also provide new ways to cure the subsidized. Channel players that address both problems first will do well versus the majority that will try to stick with their traditional mark-ups, marketing assumptions and sales compensation schemes.

At the distribution level within any given channel, who will be the first to "carpoint" the channel and perhaps also be the first to offer an activity-based-pricing, web, order-entry site? Carpoint.com is an auto-shopping site that reveals the landed cost and often sheltered income deals that dealers get from the manufacturers. Any distributor that sets up a site that posts distributor landed costs will get a lot of traffic and put a lot of pressure on all other distributors to justify their "high margins." A defensive response might try to explain the cost for each element of service that goes into the "full-service" package price. But then, some customers might request an un-bundled service contract.

In order to let the customer have it their way, imagine that a distributor sets up a site that lets each customer build their orders on an unbundled activity cost basis. For example: the site starts with all items priced at landed cost. Landed costs are then marked up about 1% to cover the cost of the purchasing departmentís work to have the goods on hand. Each item is then further marked up based on how many times it turns. If, for example, a distributor assumes that annual carrying costs for inventory are 18% or 1.5% per month, then items that turn 18 times per year would only be marked up by an additional 1%. Items that turn .5 times per year would be marked up 36%. There is a flat charge for each line item placed on the order to reflect the cost of receiving, stocking, pulling and packing an item. True freight to a customerís location is unbundled. All transactions are done by credit card. Customer service is available via a 900# with a published rate per minute. And, then there is a healthy flat charge added to cover all other overhead expenses that include profit, but not any outside sales coverage or any other special services that full-service distributors might typically provide.

The heavy users of this site would be larger customers who would buy only their large orders for fast-turning items at great savings over their normal contract prices from full-service distributors. The smart customers would still give their small orders for slow turning items that needed extra service attention to traditional suppliers that offered lower prices for such orders than the cost-plus web site.

Would cherry-picked distributors figure this out before they went out of business? How would they go about enlisting their outside and inside sales people to embrace and promote a similar cost+ offering? And, what should any distributor do right now to create web-based solutions aimed at either shaping up or shipping out all of the subsidized elements of their business right now?

Why not rank all customers based on estimated profitability in a quick effective way to zero in on the customers that are abusing the small order privilege? A surgically targeted letter to small and periodically slow paying customers could then inform them of either a higher minimum order size or an additional service charge for all orders that are not entered via the web with credit cards replacing traditional trade credit. Now they will either become profitable or take their losing business to the competition Ė a win-win proposition.

Slow moving inventory items need to be marked up. How customers are informed that "service items" have been marked up to minimize the companyís losses on them, but still provide service for the customers is a delicate, but necessary detail.

As for the non-movers, they need to be aggregated in one, master-stock warehouse within a distribution chain if not in newly emerging master distribution centers to serve all distributors and end-users. There are dotcom initiatives in some vertical channels to aggregate all non-stocked factory items in new master distribution centers on a consigned basis from the producers. These items will be searchable on distributor web sites. Customers will then be able to do their own order entry for drop shipped items with a virtual re-seller commission going to the distributor on a periodic summary basis.

If any of these scenarios sound daunting, then stay tuned to www.merrifield.com. As initiatives for executing all of these ideas that are underway go public, we will report on them. In the meantime, realize that cross-subsidies that have grown to dangerous proportions from original, simple mark-up schedules, commission plans, shorter lines and assumptions that all customers would eventually be good customers are doomed. Will your firm steam-roll these opportunities first or be part of the digital road?

Merrifield Consulting Group, Inc. Article # 8.17