Kyle Raynor, CEO of CSI, smiles when he overhears an inside sales-rep taking a rush-order for a small-dollar item. “Sure, both CSI and the contractor are going to lose a lot on that order’s activity costs for negligible margin and spend amounts. The contractor is suffering downtime costs on a job that can’t be billed to a customer. And, we can only hope that the customer isn’t dissatisfied with the untimely service performance. But, now we have the supply chain math tools to turn all of these types of hidden costs into gold for all three parties: CSI, the contractor, and the contractor’s customers.

CSI Background

CSDI is a $50MM regional distributor in a big urban area. They have one big central warehouse out of which they sell commercial-scale contracting jobs and a number of “branches” that sell walk-in business. Most of the branches get inventory replenishment nightly on the third shift along with orders on items stocked only centrally which are then cross-docked for next day pick up or delivery out of the branches. Profits have been unsatisfactory for the past 4+ years and employees are not happy about their total compensation trend during those years.

CSI has always known that they have had lots of unprofitable – picks, orders and customers – hiding within the financial numbers. But, they never seriously considered developing an in-house capability to build “accurate-enough” “cost-to-do or serve” models to identify with certainty the winners and losers. They tried a simple customer profitability model. But, it revealed that “best customers” who had many vans/techs doing counter business were often the biggest losers. Sales reps were generally getting big commissions on these losing accounts, so they resisted making any changes.

No one had any idea of how to turn the losing customers into winners and handle best rep concerns. The unspoken assumption was that the customer was buying in a way that was best for them. No one suspected that some of the customers could be unknowingly inefficient buyers who were hurting their own bottom line too.

What CSI Learned At APIC

CSI got a glowing recommendation from an industry friend to attend one of the semi-annual “Advanced Profit Improvement Conferences” (APIC). At the conference, they learned some key insights:

1. If you have a “good enough” model for calculating the net profit or loss on every line- item, then you can take this smallest-increment of profit information and sum it up to create P&L statements for every customer, customer-category, item, supplier and goods category.
2. When elements are ranked from extremely profitable to extremely unprofitable, no matter how you tweak the model,the items at the extremes will shift a bit, but always still be best and worst. They should be acted on immediately. By “innovating at the extremes” huge net-profit improvement leverage is possible.
3. Being super profitable or unprofitable is a symptom, what are the underlying root cause(s)?
4. To find the root causes, you need the properly constructed database, cross-sectional analysis tools. The Four-View Analysis of an extreme customer always works. By looking at a losing customers: (1) P&L; (2) SKU profitability/pick ranking report; (3)invoice profit ranking report; and (4) applying local team knowledge – the causes and solutions emerge.
5. The “Law of Reciprocal Costs” is the key to turning lose-lose relationships to win-win ones. The “Law” states that in a buy-sell process business like distribution, if the distributor has activity costs on their side of the fence for working with a customer (or a supplier), the partner has to reflect more-or-less those same costs. So, a big losing customer is buying in a way that is always costing them in a reciprocal big way(s); the costs are just hidden or seemingly un-measurable and intuitively underweighted. If a distributor has the supply chain math for a given relationship, then that math provides equal insights into the partner’s total system costs in the relationship.
6. If you don’t know where you are going with line-item net profit information, you won’t go anywhere. WayPoint helps clients find the causes, learn insights from them, come up with plays/cures for them and then track those play results while putting the entire organization on the same net-profit improvement incentive orientation. Each of these success factors requires complimentary education to overcome traditional, math-free, spiritual beliefs. Waypoint provides that necessary education too.
7. If you subscribe to WayPoint, a distributor gets 5 big economic benefits in contrast to trying to invent what they offer on your own:
   1. A web service allows a client to instantly get going v. having years of upfront investment and creation efforts to mimic what a web service offers immediately.
   2. If the service focuses on one particular industry (distribution), an entire array of tools is apt to work for all common activities on a turnkey basis. No need to rebuild some comprehensive capability on a one-off basis that may take a long-time a lot of expense and might not even work. ­Don’t build Rome over time; get all benefits in 3 to 5 weeks for negligible upfront cost.
   3. New information reveals new insights that will take new solutions and skills education. WayPoint offers a lot of such training and a community of users with whom to network.
   4. And, the growing community of users continues to push WayPoint to make continuous improvements to theservice that are instantly available to all users for the same flat monthly price. No upgrade and seat license fees.
   5. Because the set up cost is minimal and the monthly fee is far less than the new free cashflow that can be achieved, the service can be (based on execution speed) instantly cash-flow positive and therefore risk free. If you can’t use the service, stop subscribing after three months. The downside-risk costs are minimal and known right up front.

   Macro, Whale-Curves And First Reveletions: “Cherry Pickers” And “Pinches Of Spice”

   Once CSI decided to sign up for WayPoint Analytics web-service, a “Profit Development Team” was put together based on a successful model that another WayPoint “power-user” (in a different distribution channel) was using. And, the team did the process steps outlined in “Insight #28” to quickly zero in on their first experimental big-losing customer. Here is what they specifically discovered.

   The peak, internal profits climbed progressively higher on the whale curves for the most profitable: customers (20% →150%), suppliers (20% → 200%), SKUs (20% → 500%) and finally, line-items (30% →750%).¹  But, then each of these whale curves had bigger, more severe tails to all settle at the same too-small, financial operating profit total. The biggest shocks were:

   1. How a few large contracting companies were killing profits by buying lots of little items in small quantities at seemingly low-margin rates. The worst customer (call them “Darth”) had: sales of roughly $30,000; at a margin rate of 22%; with an average order size of $15 (2000 orders per year; 8 per day spread over a few branches); an average transactional cost of $60; and annual loss of over $100,000! Because Darth was a big contractor who had to be buying $200,000 or more in total purchases per year, he was cherry-picking CSI for emergency needs from the nearest convenient supply source which 2000 times in the previous year happened to be a CSI branch location.
   2. And, how 300 SKU’s were also killing profits. These items were being bought frequently in small, average amounts per line item. Many customers were buying these job ingredients like a cook going to a store with a recipe who then buys the equivalent of: pinches of different spices; one egg; one stick of butter; etc. And, unlike today’s, help-yourself grocery store, CSI counter people were hand picking these small lines and using an in-house invoice system that is too paper-processing expensive for small orders. Like retailers, CSI needed to immediately experiment with bundling some of these items from a pinch of salt to a shaker or 1 AA battery to packs of 4 and 12. The math revealed that customers were buying the items often enough to support the bundling option. And, CSI needed to look into switching some customers and/or orders to cash or credit card cost-to-serve models.²

       

      What Did The 4-Venn-Diagram – Circles Process Reval By Customer?The CSI team started with “Darth” (mentioned above) and did the four-step process outlined in “Insight  # 28”.  Darth had a P&L revealing a loss of (S113,000). Because Darth was “BIG”, they were assigned a rep who was getting $1500 in commissions out of the $6600 in margin dollars from the account. Darth was also getting: no order-size minimums; free delivery; and contract-price deals on popular supply lines. But, on those lines, Darth was only buying the parts and pieces within the line, not any of the 10% of the SKUs that accounted for 90% of the sales volume.The SKU report showed a dearth of all A+ profitable items, which a big contractor has to buy in volume (obviously Darth was from other sources) and otherwise a wide range of C-store and odd-ball items. The invoice ranking report also showed scads of small, one-item orders suggesting emergency fill-in needs. CSI was being cherry-picked for their location and excellent, topped-off every night fill-rates and giving economic discounts too. They needed to either renegotiate the total relationship or sell this type of customer like Fastenal would: 30% higher prices; cash or credit card; find it and pick it yourself.

      As an experiment, Kyle called on the Darth owner himself (without the sales rep) to explore re-negotiating the relationship. If Darth was unwilling to change the volumes, mix and/or terms so that CSI could serve them profitably, then Plan B was to inform them that they would be sold as: a house account (no rep); only on a cash/credit card basis; at full, list prices with a minimum order for delivery and unbundled delivery charges. Darth would not renegotiate and threatened to “never buy from CSI again” when presented with Plan B. Darth did stop buying for about three weeks, but then his vans were back at the counter thereafter on the new, profitable terms. Why? Because CSI still had the “cherries”:  the convenient locations and high fill-rates which kept Darth’s technicians clocking job time.

      Semi-Custom Spice Racks For Loyal, Small-Line/Order Losers

      Aside from Cherry Pickers, there were plenty of large, loyal contractors who were also losers. As a first-time, experimental candidate, the team chose a particularly friendly, affable customer: call him “Homer”.

      Homer had 5 vans/technicians that were at one location’s counter every morning and often multiple times during the daygetting exactly what they needed for job ingredients to comply with Homer’s “zero inventory” policy. Homer figured that CSI’s location was near his base, so he could work off CSI’s inventory and not have his own investment and suffer shrinkage (he had had a previous inventory-theft, traumatic experience).

      In 2012, Homer did:  $128K in sales; at a 20% GM rate; with a net-profit loss of ($16K) or (12.5% of sales). On Homer’s SKU profitability ranking report, the bottom 50 losing SKUs all had losses ranging from $100-800/SKU for CSI.  The pick frequencies ranged from 127 to 454 for the year with an average of 251 or 20+ picks per month.

      At the bottom of Homer’s ranking of invoices by profitability, there were many one-line-item orders for the same “worst 50” items. It appeared that Homer’s techs were often forgetting to buy some items on their shopping list and then later, in the middle of job, realizing they needed a pinch of some ingredient.

      The CSI Team then estimated ranges for these possible hidden costs that Homer might be suffering:

      1. How many times (annually) were his techs forgetting to buy one ingredient at the beginning of the day and having to interrupt a job to go back to get the missing ingredient?
      2. How badly did job-interruption-buys hurt the contractor’s Uptime Ratio: “hours-billed-on-a-job divided by payroll hours”?
      3. What did this cost the company in profits and the techs in incentive pay?
      4. How dissatisfied were the customer’s customers that jobs were taking longer to do for lack of a miscellaneous item? Or, that…
      5. …the next job had to be rescheduled later in the day or the week?
      6. What was the full cost of invoice paperwork processing? Too much for $5 buys!

       

      They configured a “rapid prototype” storage unit that could go on each van (in some final, co-created form) with just-in-case needs for the “worst 50” items. The extra inventory investment and possible shrinkage-losses were negligible in contrast to the huge impact on the five costs above. And, CSI would have – 1000 fewer line picks and 250 fewer invoices to process – which would make the account solidly profitable.

      EXTRA BENEFITS

      The contractor instantly believed CSI’s math and his reciprocal side. He loved the entire proposal and pointed out more unaccounted-for upside benefits. CSI sales would be higher, because his techs had been getting more emergency needs from whatever supply location was closest. CSI’s custom spice-rack would pick up much of that action. And, Homer speculated that by focusing his techs on boosting billing hours for total payroll hours for extra pay, they would become better all-around planners and timely, service providers. How could repeat business and more, better customer referrals not happen? This should help his business and purchases from CSI both grow- profitably!

      Case Study Discussion Questions:

      1. Are all customers equally effective, disciplined buyers of goods from distributors? Who are the best, how and why? What best practices and purchasing education and metrics are they using that other customers quite like them (except for challenged purchasing practices) could benefit from?
      2. Even best customers may have pockets of buying inefficiency that the 4-View-Analysis will reveal. How should we go about approaching some of these customers to help both of us grow our bottom lines?
      3. If we pay reps to get only gross margin dollars, then they can’t be focused on also selling products to and through their customers in the most totally effective way. How could we? Should we migrate towards paying them an incentive on growing/improving the net-profitability of their customers?
      4. Full-time buyers are not measured or job-security motivated to reduce inefficiencies within their office (paperwork, expediting, shopping-time for best prices is what they do). How do we as a team get a meeting with someone high-enough up in the customer’s organization who can see the big picture, realize it could be win-win improved and the power to make it happen?
      5. If no one person or team has every analyzed the inter-business processes that exist between you and your customers, then there is apt to be some first-time, low-hanging fruit opportunities. How much profit-improvement upside do your macro whale curves and whale tails suggest that there is to capture? What other best ideas do you have for improving your overall business profitability, productivity and wealth of all of your stakeholders?

       

      ANSWERS TO ALL OF THESE QUESTIONS CAN BE FOUND IN BRUCE’S 338+ YOUTUBE EDUCATIONAL VIDEO CLIPS. THE ANNOTATED INDEX TO THE CLIPS IS AT THE TOP OF THE HOMEPAGE AT WWW.MERRIFIELD.COM.

      Strategic Insights 28

      D. Bruce Merrifield, Jr.

      1. (The increasing peak profits – 150, 200, 500, 750 – is logical, considering the potential for offsetting losses within an element’s profit total. (1) Profitable customers will have their overall net-profit-total lowered, because they will have – during a measured time period- some losing line-items, SKUs and order activity. (2) Supplier lines will also generally have some both profitable and unprofitable SKUS in their line which dampens the overall profit or loss for the line. There are some suppliers who just make big-volume, big gross-margin-dollar-per-pick items who will be quite profitable. While suppliers that make lots of bits and pieces will be big losers if distributors choose to sell those items one-at-a-time, per line with a high-cost service model (by contrast think of how the Dollar Stores sell small items). (3) SKUs tend to be a more pure play on gross-margin-dollars per line which allows for greater extreme peaks and tails. And, finally (4) line-item net profits have no internal profit/loss offsetting going on. Every line item is either purely profitable or unprofitable.  ↩
      2. On team member benchmarked CSI’s counter experience against buying 2 similar items from Home Depot. Using his stopwatch, it took him 5 minutes to park, walk to the appropriate product section, find the two items, self-scan them and swipe a credit card for a total purchase of $7.23. CSI’s service model costs $8 for just a pick. CSI is guilty of both not innovating enough cost of their branch replenishment and personal service model and under-charging for their time-saving convenience proposition.

    

   Link to Insight 28:  Turn Losing, Line-Item Activity Into Gold . ↩