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The Power of Transaction Thinking

February 15, 2011
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Rocky Balboa, the famed “Italian Stallion” of pugilist excellence, had notable one liners in his first film.  Several stick with me, including naming the turtles “cuff and link,” and the Bull Mastiff “Butkus.” I remember, “Yo Paulie, your sister’s with me,” and when punching sides of beef for an upcoming fight, telling the news reporter, “I think I invented it.”

Taking Rocky’s lead, I am inventing a field of business philosophy called “Transaction Thinking.”  Like punching sides of beef for boxing prowess, the philosophy has yet to be thoroughly tested in the business of distribution, but I think it has at least as good a chance of adding value to the discipline. 

What is Transaction Thinking?

Transaction thinking is simply tracing transactions through the firm with reasonable detail including:
  • Different types of transactions and their labor components.
  • Different transactions have different costs based on labor differentials.
  • Different transactions have different profit profiles based on their size and cost.
  • Broken down by customer, time period, branch, segment, etc., the mix of different transactions can have a substantial effect on the entities’ operating profit.
  • Transactions can be managed for profitability, including investing in a transaction type, shifting from a low-profit transaction to one of higher profits, and minimizing or deleting a transaction type that loses money.

To adequately address transactions, one needs to model them, understand their cost structure and labor inputs, and be able to accurately track them in the regular course of business. As with any new idea, most think that performing any rigorous review of transactions to be extreme and unwarranted. Transaction thinking, is reminiscent of the recently deceased Jack LaLanne who began body building in the 1920s at which time, he later admitted, “People thought I was nuts.” 

Transaction thinking may have the same fate or maybe not. There may be some distributors and supply chain businesses who have been thinking about transactions for some time and doing quite well against those who don’t.

The Case of the Wedding Band

I write blogs, articles and books about supply chains. The amount of material I spew out is considerable and does not come without a cost. One of the costs is physical and includes growing osteoarthritis of my hands. Several years ago, my left hand began to swell and a visit to my sawbones diagnosed it as osteoarthritis, most likely due to excessive time at the keyboard.

My wedding band of 20+ years had to be “sized up” two sizes to accommodate my condition. Arthritis is fickle, however, and last year the hand returned to normal size. The problem is my ring was never downsized and I proceeded to lose it on a cold, early November day when raking leaves. No amount of searching could find the ring, so I decided to order inexpensive replacements in preparation for the arthritis to return. A visit to several local jewelry stores found nothing inexpensive but, to my surprise, the best selection was from Amazon.com. I quickly ordered two sizes and they arrived within a week.

The offering of a wedding band at Amazon got me thinking - what else do they carry? I thought the entity offered only books but I was surprised. Amazon.com carries more things than I can think of, including small Swiss Army knives that I never seem to take off my person before going through an airport magnetometer. 

Since Amazon.com is a supply chain business I began to wonder how and why they carried so many unrelated items. My traditional product-based thinking in distribution didn’t help much. Books aren’t related to wedding bands, which aren’t related to Swiss Army pocket-knives, with the exception that I use them all and have an Amazon account. Bingo! The common denominator was that I had an Amazon account and ordering was quick and easy.

However, I still couldn’t understand why Amazon carried such unrelated items until my rings and knives were shipped from small companies that I’d never heard of. In essence, Amazon doesn’t “carry” these items and, my guess, really doesn’t want to. They provide a link for their suppliers, hook up the content, and launder the transaction through their site. It’s a lot easier for a user like me to order through Amazon.com than to do numerous searches for unrelated items. The other benefit is that I trust Amazon. They are a big company with a household name and I’m confident they wouldn’t deal with substandard suppliers.  

In thinking about the Amazon strategy from a transactional perspective, my Swiss Army knife order was significantly less than I could buy it for at a local retailer, even with freight and handling a third of the final bill of some $25. I don’t know what margin percent Amazon made on this transaction, but it probably isn’t much.

What I do know, for most businesses, is that it is difficult to fulfill a transaction (order, stock, pick, pack, pull, ship, extend credit) for anything close to $25. But Amazon doesn’t fulfill the order. They control the buying system and simply launder the transaction. Furthermore, their control point, their site and content, is ultimately scalable in that once it’s done; you can process thousands of transactions through it. My guess is that Amazon makes more profit on their transactions than many of their suppliers and they do much less traditional “work” for the transaction. This is transaction-based thinking at its best, but you won’t find it in distribution, right?

If anyone has been reading business magazines lately, they have had to run across W. W. Grainger’s significant expansion of product offerings.[i] A year ago, the company added 85,000 new products to their catalog. This is a significant number of skus, and stocking and supporting them would ultimately cost a bundle. My supposition is that many of the products are fulfilled by outside entities. Grainger controls the transaction and, ultimately, the channel by controlling the customer interface and, if the company knows their transaction costs, they probably make more profit on many of the transactions than their suppliers do. Maybe this is why Grainger makes 7% to 8% in pre-tax profits whereas most distributors make 2% or less.

In fairness, I may be totally wrong about Amazon and Grainger. They may offer these items as a service to their customers and make only a small amount of profit on them. Or they may stock many of the diverse and numerous skus they offer for sale. But my transaction thinking says that when one thinks transactions and cost and how they are moved through the supply chain, the traditional model of purchasing, stocking, answering customer needs, and product knowledge gets twisted around. The value added power in the channel then comes from understanding how and where to use knowledge to make a buck.

In essence, in transaction thinking, one can enter into different parts of the vaunted value chain and make lots more money than if they did all the traditional stuff that distributors say they do.  In fact, properly addressed, a well-executed Amazon-type strategy could conceivably add a lot of value for the customer and with very little cost other than updating the e-commerce site. Weigh the relative profitability of a traditional distributor taking on a significant product line - stocking, balancing inventory, juggling cash flow, and supplying product knowledge - versus a company that knows the transaction costs of the supply chain and how to break it apart with technology and add services where it makes sense?  

Melding of Industries and Economics of Order Size

Transaction thinking is not limited to an e-commerce strategy. I recently ran across a competitive situation with a client where my advice was to cut your losses and get out. The client was a supplier of chemicals where their value added is extensive product knowledge and depth of inventory. However, a large portion of their product offering is used by many firms and are commodities. When an unrelated industrial MRO supplier began stocking the commodity portion of their offering they were not worried, as the supplier couldn’t possibly offer their depth of product knowledge. However, the competing company was a core supplier whose offerings were much broader and in demand by industrial companies.

When the annual bid for chemicals came up for a mega-industrial customer, my client lost it to the industrial supplier. Why? Quite simply the industrial supplier could place commodity chemicals in their warehouse and add them on to an already large stock order of traditional products, and the economies for the end customer were unbeatable. The commodity chemicals customer didn’t value a lot of product knowledge, so they switched without batting an eye.

The industrial supplier knew two things. First, they knew their customer didn’t need a lot of product knowledge when it came to buying chemicals and second, they knew that they could drive the transaction size up considerably by adding these products.  

If it’s not clear what I mean by driving up the transaction size, consider the following example. If a stock order costs $50 to process and the firm needs a 25% gross margin to cover operating expense, it takes a sale of $200 to break even. If the firm can take a new product line, add $100 to the order with incremental fulfillment cost being $10, then the $300 order gathers a profit of $15 ($300 x 25% - $60 fulfillment cost). In essence the industrial supplier was thinking and measuring the transaction economics of the situation and gave the customer a better value with their ordering costs reduced.

If one doubts the economics of combining lines to drive order size, consider the following perspective. Years ago I worked for a rep agency that sold to wholesale plumbing, water-well, sewage, HVAC, and municipal water entities. Today, it’s hard to find a stand-alone water well and sewage wholesale supplier. Many companies serve the industries from one warehouse where, a quarter of a century ago, it took five warehouses and five separate suppliers. The channel took cost out as products matured and information became better and easier to manage. Companies could aggregate demand patterns for different customer bases and broaden the product offerings.

For the most part, the plumbing, HVAC, water well, etc., customers get a better value than they did years ago when dealing with numerous suppliers, much of it due to the ability of the consolidated supplier to increase their order size and lower transaction costs. Hence, another version of transaction thinking is evident and that is the melding of industries dealing with contractors. Will we see melding across other contractor-based industries, including electrical and building material suppliers?  I don’t know but it wouldn’t surprise me. The economics of order size are hard to beat, especially as products and their supporting knowledge matures.

Where Invention Isn't Really Invention

My invention of “Transaction Thinking” isn’t really an invention. Other firms have been using transaction economics for competitive advantage for some time. I may have coined the phrase, studied up on the knowledge and how to use it, but the power of thinking about the supply chain, knowing its discrete costs and how the value is perceived by the customer is increasingly less optional in distribution channels if one wants to succeed.

Like Rocky Balboa, Transaction Thinking is the left hook that puts Apollo Creed on the mat. Distributors who can deliver the punch, shouldn’t be surprised at its power.


[i] http://www.mdm.com/grainger-adds-85000-products-to-catalog/PARAMS/article/25660

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