CASE STUDY: ABC DISTRIBUTION RETHINKS THEIR "PROFIT POWER"
ABC Distribution has for years pushed an expanding array of supplier lines and SKUs to diminishing return limits of its geography and active account base. A few years ago, ABCís management found that they were working harder to have less fun and no profits. Their statistical profile at that point was: $10MM in sales, 1000 active accounts, 250 suppliers, 10,000+ stock keeping units (SKUs), 8 outside sales reps and 34 total employees. There financial profile and performance stats included: no debt, break-even profits, 3 turns on inventory, a 25% gross margin, 39 days outstanding on receivables and 73.5K in gross margins (or value added dollars) per employee.
They started their strategic reinvention process with a customer profitability ranking report (map 1) to discover that:
- the top 10 accounts generated $64,000 in profits at an average of 8% PBIT margin;
- the bottom 20 accounts lost $80,000 and included some big name, "good" accounts;
- 5 of the top 10 were all large firms that could be grouped into a certain segment of customers that probably bought a common-basket of items that another 50 A and B sized accounts in the same niche would probably also buy.
(For more on their customer profitability ranking process, see slideshow # 10 on this site.)
To do some quantitative analysis on the underlying economics for the 5 similar, super winners, ABC did a common purchased item analysis. They discovered that all 5 customers in the niche bought 100 of the same items, another 100 items were being bought by at least 4 of the 5 and 200 items were being bought by at least 3, etc.
The two reports above changed managementís thinking about their source of profits. Fifty years ago, the company had a number of supply lines on an exclusive territory basis for which they did product promotional efforts to expand market sales. High turn x earn products sold in good volume were believed to be the source of profit power.
Management realized that somewhere along the way, the company had lost all of their meaningful exclusive product power and had unknowingly started to add items and sometimes suppliers to accommodate demanding, "best" customers. As a result of the common item analysis for their number one niche of customers, management concluded that at least within their #1 niche, they had a critical mass of similar customers buying a common-basket of items that made all of those items seem profitable. How much more opportunity was there to sell more of these common items to more of the top 50 customers in the niche? What was the best way to retain and sell more to best accounts?
To both leverage the economics of selling more "old products" to old customers in larger average order size and retain/grow accounts in their number one niche, management reviewed their target fill-rate strategy for SKUs. They reasoned that fill rates for a one-stop-shop assortment of items is the cornerstone of good service, because on-time delivery, zero errors, etc. canít happen if goods are out of stock. They also questioned why they were trying to hit a 92% fill rate for inventory across ALL items, Aís to Dís. Why not invest in the top 500 common items for niche #1 to hit 98%+? They did the math and decided to beef up the "strategic nicheís common items".
The higher fill rates had some interesting benefits:
- The average order size of shipments increased immediately while the number of small, extra orders for stocked out balances from elsewhere decreased. Productivity for order fulfillment personnel measured by gross margin/employee went up 15% in one month!
- Sales to the entire target niche climbed immediately due to the increased fill rates. Fewer stock outs was apparently increasing retention/penetration and decreasing defections. If two, local competitors going after the same niche have average fill rates of 99% and 92% respectively, what will happen to retention and defection rates over a period of time? The first, with a 7% edge, will overtime win more of the niche share.
- Order fulfillment personnel morale climbed. They had to say "Iím sorry, we donít have it" to core customers less often. They were saying, "yes, we have it" to non-core customers in the same niche who were grateful. Less work, better numbers, better service pride and less stress all helped. They were the beneficiaries of working strategically smarter, instead of harder due to an unfocused strategy.
To better understand the needs of the niche that contained the 5 similar, profitable customers, management visited them and 5 others most like them for whom ABC was not the #1 supplier. The managers went through the value creation/improvement process (slide # 9 in slideshow # 10) and identified a few service improvement wrinkles in addition to the fill-rate improvement strategy that would lower common customer frustrations and improve the customers' total procurement cost (TPC) as stage 4 of the life-cycle map (#3) suggested.
One of the wrinkles was determined to be an "extra service" that would be free to the top 5 profitable accounts, because they were already averaging an 8% PBIT rate when 5% would have historically been a dream. As an experiment, they decided to offer the extra service to 3 of the 5 most important target accounts in the niche on a limited free trial basis as an account-cracking tool. The other 2 prospects were dropped, because they had revealed an emotional commitment to another supplier. All other accounts in the target niche were initially projected to pay a fee for the service if they should eventually want it.
After the service improvements were co-created using the "push the wheel of learning" model (Exhibit 24), ABC had to change some service process systems and do some cross-training of personnel to fully support the new services and higher basic service standards that were to be hit. The PBIT/customer strategy had begun to change the processes in both the department and individual activities. Some employees grumbled, at first, about the changes and were slow to understand and believe that they along with everyone else could be better off in the long-run with these efforts. But, good critical mass leadership and enthusiasm throughout the company helped to push the rest along.
All 8 accounts that were interviewed and still targeted were team sold for one year. The 5 most profitable accounts grew by 30% even though the sales reps assigned to these accounts had initially felt that "we are already getting all of the business". The 3 target accounts grew an average of 50% from a small base, but they kept on growing rapidly for the next two to three years until ABC had become their dominant supplier. The sales reps sold the next 20+ most promising customers in the niche the new service value story with heavy marketing support help to get strong, new penetration growth.
About 18 months after the service re-invention process had begun at ABC, a competitorís management team visited with the now lost 3 target accounts to find out why they had switched (Map 5; step 6). When the targets told them about the higher, guaranteed service standards and the new extras they were getting from ABC, the competitors vowed to meet and beat the service, but they never did. They offered, instead, more aggressive contract prices. ABC got last look and kept the business without lowering the price, because they were still offering a lower TPC supply system in the minds of the customer.
ABCís FINANCIAL RESULTS
ABCís numbers started to improve immediately for a number of reasons.
- Sales started to grow faster than the industry due to service retention benefits.
- Profits grew much faster than sales because of the flow-through of incremental margin dollars from selling more old items to both old and new customers on a systematic, larger average order size.
- There were other, bigger, faster profit improvements that came from ABC addressing both the biggest losing accounts and the small order, small account opportunities, but those are other stories covered in later chapters.
www.merrifield.com Exhibit # 25