A new way of business best served cold.
Wholesale
distribution is a slow-to-change business. A review of the current research
should testify to the accuracy of the statement. In recent months, we have
chronicled research in sales compensation at a time when all signs point to
less need of sellers both inside and out. Much substantial change for the
wholesale industry is brought in from the outside. Knowledge of modern inventory
management, activity costing, customer profitability and capturing value with
pricing all had their roots outside of the industry.
In
fact, for knowledge that moves and shakes the staid old sector, it is hard to
think of any managerial knowledge developed from inside the industry that does
more than cause a few tremors and moves much faster than the mile high glaciers
of the last Ice Age. Hence, we tend to look outside the industry at
technologies and trends that converge and will have significant impact on the
sector. In our study of value generation[i]
(return on capital) for wholesaler investments in sellers, branches, customers,
transactions, and vendors, the single greatest impact on the industry - in many
a year - will be wrought by changes at work outside the industry.
The
changes we are alluding to will be due to the convergence of three technologies
specifically; e-commerce as a business strategy, globalization of supply and
new models of transaction costing. The combinations of these events have a high
probability of disintermediating the current one-size-fits-all service platform
common to most wholesalers. And, once
services are disintermediated, don’t be surprised if the wholesale firm will
have to cannibalize part of their existing business to stay in business.
Three is the Magic Number
When
it comes to big change, it is rare that a new and heretofore unknown
technology(ies) drive an en-masse and quick change. In most instances, the
pieces of big change have been around for some time. In the case of breaking
apart the full service bundle, the biggest threat has been a complementary
strategy for many years. E-commerce emerged, mostly, in the last decade and as
a supporting technology for customers. Wholesalers were quick to realize the
labor savings and increased accuracy of getting customers to order online. For
all intents and purposes, e-commerce was stressed without little, if any,
discounting to induce trial. But e-commerce and the greater subject of
e-business has progressed in knowledge and acceptance in the last decade to
where, recently, we visited a wholesaler who uses advanced analytics on
incoming e-mail RFQ’s to increase the hit rate of their quotes.
Today
it’s possible to solicit, quote and land an order using e-business. Furthermore,
tomorrow’s generation of b2b buyers and sellers (now in their 20s and early 30s)
will
prefer using
the Internet over the old belly to belly sales call.
The
second piece of the big change puzzle is an accurate costing of transactions. In
years past, wholesalers have used Activity costing or watered down models of
cost allocation to help with investments in customers. Activity costing’s
original models full of hundreds, if not thousands, of variables have long been
abandoned. In their place were simplistic models that used concept(s) such as
average order size. The knowledge of allocating costs swung from too much detail
to way too little.
Precision
to the nth degree was replaced by averaging all transactions into the variable
of “average order size” which is, to us, insightful into nothing much. We use a
proprietary costing logic that typically uses 12-18 transaction types. Each
base transaction (stock, non-stock, direct, etc.) has components of outside
sales or not, inside sales or e-commerce, delivered or customer pick up. The
costing closely follows the consumption of labor by the transaction. For
instance, variants on stock transactions could include:[i]
-
Outside Sales Assigned-Order Writer-Delivered-Cost $157
-
No Outside Sales Assigned-Order Writer-Delivered- Cost $77
-
No Outside Sales Assigned-E-Commerce-Delivered-Cost $51
Transaction
costs have proven to be highly accurate in our work of the past five years. And
the logic, today, stands to become key in the move toward
disintermediation.
The
last bit of change will be wrought by global supply chains. We researched the
move of wholesalers toward sourcing foreign off-brand items versus domestically
designed but mostly foreign produced domestic brands back in 2008. Our finding
then was that there was a 30% landed cost difference in securing off-brand
purchases.
Today, while the acceptance
and use of off-brands is greater than three years ago, we find a growing gap in
wholesalers who chase low-cost manufacturing around the globe and those content
to buy from domestic vendors. Wholesalers who have active global contacts in search
of cost advantage will fare much better in the coming years than those who tend
to keep tired and often overpriced brands produced by conglomerates. The
manufacturing cost advantage is going to focused plants producing a few
products well and wholesalers who follow these entities can have a significant
advantage over the competition. Now that the three sources of change have been
identified, all that is needed is the know-how and will to bring their
advantages to market.
The Transactional Distributor Comes of Age
Approximately
a decade ago, we began researching and writing about a new group of wholesalers
called Transactional. In essence, these entities took a slice of the value
chain, reduced services and offered a great price to the customer base. Many of
the entities used e-commerce and had low-cost off brands. We dubbed them
transactional because of their focus on the transaction. Today, combining
off-brands with e-business and accurate costing, the stage is set for a
low-cost model of business that is deadly to much of today’s full-service
wholesaling.
To
convince readers of the basics of how the transaction model works, consider the
HVAC wholesaler, Rush Street Supply of Chicago. The company sells units to a
dealer base and most have a shop inventory. Currently, the average full serve
stock order (Sales Assigned, Order Writer, Delivered) is $500 at a 23% margin. The
costs of a stock order are those exhibited earlier in the article. Since the
cost of goods for the order is $408 and the cost is $157, the order loses
($42).
Rush Street’s
management moves to change the dynamics of the business to their advantage. Management,
using transaction costing, knows that the cost of an e-commerce order is $51 or
$106 less than the full service variety. They also know, however, the customer
won’t move to order online and handle any ordering hassles without financial
motivation. Furthermore, they are
convinced that they can increase the transaction size and get the customer to
inventory more with a better price. The math and the ordering logic works like
this:
-Minimum
order volumes are given at $1000, $1500 and $2000.
-Costs
for each order using the full service model are: $314, $471 and $628.
-Costs
for each order using the stripped down e-commerce order are: $102, $153 and
$204.
-Pricing
using the stripped down e-commerce order is set at a 17.5% gross margin on the
$1000 order, 15% on the $1500 order and 12% on the $2000 order.
-Transaction
profits (GM$-Transaction Cost) for each order size are: $73 for the $1000
order, $72 for the $1500 order and $36 for the $2000 order.
-Transaction
ROI for each order is ($73/$102) or 73% for the $1000 order, ($72/$153) or 47%
for the $1500 order and ($36/$204) or 18% for the $2000 order.
What
you’ve just witnessed is an example of variable transaction size pricing and
all it takes is a reasonably robust e-commerce model and an accurate modeling
of transaction costs. Consider also, that Rush Street moves to buy 25% of their
goods as off-brands and secure a 25% landed cost advantage. This makes the cost
of goods of the current full service stock order $382. That’s approximately a
$25 cost advantage which equates to a $50, $100 or $150 advantage on the $1000,
$1500 and $2000 transaction.
Consider
that Rush Street
management passes on 50% of the cost advantage to the customer. For the $1500
order, the cost of goods moves from $1275 to approximately $1175 and the
customer gets the goods for $1440 (($1175 + $50)/.85) which is an added 4%
discount from the already 8% discount from regular pricing. In short, the
customer, buying a $1500 order via e-commerce, sans sales support, and with 25%
of the goods as off-brands would get a 12% discount over the current buying
level. And the deal would get better the larger the transaction size and
greater the use of off-brands.
The
ability of the customer to garner significant savings using off-brands,
transaction size pricing, and e-commerce is typically between 10% to 30% over
the current full service, one-size-fits-all service model. The traditional
model is rendered non-competitive and will have a hard time competing with the
transactional offering. Why? The traditional model bundles up a significant
amount of negative transactions and has to keep margins high on the profitable
customers to pay for the unprofitable ones.
Structuring the business
platform with accurate transaction costs gives the wholesaler a chance to make
money on most orders and avoid losing ones.
The model of business is structured to drive profitable transactions
and this is a sea change from present practice. The existing full
service model was formed using margin dollars as an incentive for sellers regardless
of the service cost of the incoming margin dollars. Hence, the typical
wholesaler platform is convoluted with significant losses on investments in
transaction types, sellers, customers, etc. To make the model work, wholesalers
have to charge the most profitable customers high prices to pay for the losing
and low return parts of the business which is often 60% of customers,
transactions, sales territories, etc.
Disintermediation and Cannibalization- Get Use to It
Bundling
all customers and services together and using an overall margin (in the case of
Rush Street
23%) to cover all transactions, regardless of how they consume service costs,
is a model of business that is in trouble. Technology of e-commerce, global
supply chains and accurate transaction costs will unbundle (disintermediate)
the one-size-fits-all platform. A certain amount of cannibalization will take
place on existing accounts even if Rush
Street creates a new business with a different
e-commerce front, billing location, logo, etc.
The
model is especially useful in dealer-based businesses where demand is easy to
forecast and there is space to take larger orders. Too, repair businesses and MRO
and OEM customers where bin space at the customer site is used can also
participate in the new model.
The
wholesaler who launches the model will be braving new territory in most
vertical markets as transactional distributors are relatively small in number,
but we expect their presence to grow and become more mainstream. Many Generation
X and most of Generation Y buyers of wholesaler products and services will
prefer to conduct relationships online. They don’t expect a lot of sales
support and, in many instances, don’t want it on commodity purchases. Too, it
is entirely possible for wholesalers who engage transactional distribution to
perform it with smaller branch footprints and much less in the way of bricks
and mortar. The inventory strategy will, from our experience, target the high
volume A and B items to drive order size. C and D items and specialty orders
won’t be a part of the service.
Those
who doubt the viability of a transactional strategy should consider Southwest
Airlines and Aldi Markets. These companies are some of the fastest growing,
most profitable, and least cost to the customer entities in their respective
industries. Traditional wholesalers, in love with their one-size-fits-all
model, often scoff at the idea of transactional distribution and the economics
that accompany it. They point to the value added of their full sales forces and
branch management staff. Unfortunately, they greatly underestimate the desire
of the customer for a reduced price who, when they know what they want to buy,
are perfectly content to purchase it online with limited support.
When
we’ve uncovered transactional strategies in our consulting, it is usually the
bane of a full service distributor who decries a “price prostitute” in the
marketplace. What they don’t realize, and often can’t come to terms with, is
that they’ve been upended by a new model of commerce that is more cost
effective, with a smaller footprint, and more accurate than their sales driven
“get any margin dollar that’s out there” business. In all cases where the
transactional model takes hold, we’ve yet to see the traditional wholesaler
gain back much, if any, of the lost revenue.
i Blog
post excerpted from an upcoming Benfield Consulting book, “Building Value:
Driving Wholesaler Returns through Strategic and Tactical Investment.” 2011 All rights reserved.
ii Costs based on
Benfield Consulting transaction cost modeling 2006-2011. Links
