Profits are hurting for most distributors, and the “Great Recession of ‘09” could linger for some time. But, many distributors could be quickly making solid profits if they decided to cure three profit-destroying factors hiding within their customer portfolios. They are:
- About 1% of all of our customers are super-losers, because they order a huge number of small orders for which the total “Cost to Serve” (CTS) exceeds the margin dollar contributions by at least a 2:1 ratio. Because the sales and margin dollars from these accounts are often significant, we need to have some information tools for identifying and tracking these accounts and some alchemy recipes for turning leaden losers into golden-profit contributors. (For tools, we use WayPoint Analytics, see last paragraph. For alchemy recipes go to article 4.10; http://www.merrifield.com/articles/4_10.asp and exhibits 44; http://www.merrifield.com/exhibits/Ex44555kit.pdf and 57; http://www.merrifield.com/exhibits/Ex57.pdf at www.merrifield.com.)
- A big chunk of chronically-small customers that have been accumulated over the years that have and will continue – if allowed – to order small orders for which the average cost of providing traditional wholesale services will increasingly exceed the margin dollars in the orders. (Solutions for this in articles 2.15 & 2.19 at merrifield.com) http://www.merrifield.com/articles/2_15.asp & http://www.merrifield.com/articles/2_19.asp.
- We have too many sales reps to cover the 10 to 20% of the accounts that have enough annual sales, margin dollars and order-size potential to cover the CTS which includes sales rep compensation.
Fortunately, problems 2 and 3 can be solved together to generate five new streams of profit contribution. To overcome traditional industry thinking that more reps on straight commission are always good, do this analysis for your own business.
ACCOUNT PURCHASES / MONTH TO JUSTIFY OUTSIDE SALES COSTS
Let’s look at the true cost ratios for sales force coverage1:
- Take the total cost of your sales force (including compensation, benefits, meetings, education, coaching, office space, travel expenses, etc.) and divide it by (number of reps yr x number of calls per day x 230 sales days/). By example: $800,000 for 8 reps who average 5 calls/day x 230 selling days yields $87/sales call. The cost per call for rookies will be less and for vets higher. (Tune your input numbers as needed; the final prescription process will still be roughly the same.)
- Calculate the per-call Gross Profit requirement to offset this cost by dividing the Sales Call cost by the commission/compensation) rate of the GP$. By example, if we pay 25% of the GP dollars in commissions, then we divide $87 by 0.25 to get $348 in GP needed to break even on the selling cost per call.
- What then would be the sales per call to breakeven, which will vary by the overall average margin percent for the channel and the company? If our company gross profit rate averages 20%, then we would need 5 times the breakeven, GP$/call figure, or, $348 x 5 = $1740 for every call made on an account. If we average 25% in GP, then sales/call breakeven drops to $1,392.
- What minimum number of calls per year must a rep make on an account to accomplish:
- Having a good personal rapport with all decision influencers? And…
- Being able to sell, install, maintain and continually improve some degree of a “purchasing contract/replenishment process” that every smart buyer wants in order to lower all elements of “total procurement cost” especially, of course, “price”?
- A most common estimate from audiences has been one call per month minimum; biggest accounts get more.
- What then is the minimum amount of purchases per year by an account to support minimum outside sales coverage? 12 calls per year at $1392 in sales/call would equal $16,704; at $1,740/call, the annual minimum threshold would be $20,880. Let’s assume going forward the 12 call/year, sales-rep-service, minimum, annual-sales level is $18,000.
HOW MANY “A, B, C AND D” ACCOUNTS DO WE HAVE?
How many accounts does the firm currently have that are assigned to outside sales reps that fall below our minimum $18,000 in annual sales? The typical distributor will find that about 70% of assigned accounts fall below this minimum threshold. Let’s call those that are above the $18,000 level, “A” accounts. How many are there? (Hypothetically: if reps could only be assigned to our existing “A” accounts – or ones that would quickly grow past 18K in purchases – how many reps would we need with how many total accounts per territory?)
And, what should be the lower, sales or gross profit/year boundary for “B” accounts that we must serve with a (new, experimental?) lower-cost marketing method than outside selling? (For example: a blend of tele-marketing and direct e-mail and/or fax-grams with strict minimum order sizes; higher freight or transaction charges; must enter their own orders electronically; etc.)? Let’s say the lower boundary might be $100/month in gross profit. How many active B accounts do we have?
Finally, how many “C” and “D” accounts are there below $100/month in gross margin?
When reviewing the A-D account mix in each sales territory, how many “A” accounts do our weakest reps have? What would happen if we could free up some time for our best rep to call on those “A” accounts instead? How fast might top 10% reps get more business on a profitable basis out of “A” accounts being served by bottom 10% reps?
ACTION PLAN THAT YIELDS FIVE, NEW, PROFIT STREAMS
In my personal experience since the ‘70s, doing turnarounds for myself and my clients, we’ve have evolved a solution for these seemingly separate problems:
- Over-served small accounts which creates chronic losses;
- Weak reps under-penetrating A account potential; and,
- Compensation plans that reward reps on margin dollars from customers that lose money on a true, CTS basis, which motivates them to work against management who typically gets paid on profits. And, in the long run, the sales reps are hurting themselves – and all stakeholders including suppliers – by destroying profits that could have been reinvested in the business to strengthen and improve it.
Here are the solution action steps:
1) Identify the two weakest reps and the one Best Rep to create one, combined, large territory comprised of 100% of each territory’s accounts for a total of 300%.
2) We let the two weak reps go and assign the best rep to the top 30% accounts out of the combined 300% to create a new territory that has:
- Pure A accounts
- Far fewer total accounts than Best Rep had before, but typically with about 50% more gross margin dollar volume to maintain and unknown, upside margin potential to crack.
3) Best Rep is than put on a salary equal to his W2 total from the previous year (no real pay cut or downside risk) along with a “positive, delta PBIT” bonus. The rep must improve the total PBIT (profit before interest and taxes) from all of the assigned accounts to receive a big percent of that change (“delta”) Next year, the rep will still be on the same salary base – perhaps with a raise – but must once again achieve a new, “positive, delta PBIT” for another bonus. We are now paying the rep for “penetration” and “total cost-to-serve” optimization not just “maintenance” of margin dollar flow from accounts that may have been inherited. And, we have lowered the total sales cost as a percent of the margin dollars being maintained for an instant cost-savings, profit line contribution.2
4) The 270% remaining accounts are carefully analyzed and put into at least two piles:
- Some are so small, dying and not even in our best niches of customers to serve that they are sent a letter dictating our new minimum orders, and unbundled fees for doing business. We are happy to sell any customer, but always on a profitable basis. Most may leave, however, to go to either a competitor that unknowingly will provide traditional distributor service for which the costs exceed the margin contribution or to a retail-store, business-model supplier that can make money while serving them. We will then have excess fulfillment cost slack to either lay-off or let it flow into better service for our remaining accounts that have a profitable growth future.
- Some will have positive upside potential that warrants a new type of alternative marketing experiment orchestrated by a new, young, different skilled person than the two reps that were let go.
- Other piles? Depends on the channel and the distributor portfolio.
5) This overall, rep-territory rationalization process can be repeated multiple times within a large sales force. Going from 10 reps to three best reps serving only A-accounts is, at the extreme, a possibility.
A SUMMARY OF THE FIVE NEW SOURCES OF PROFITS
1) The B-D accounts that leave will take some margin dollars with them, but the firm can track the declining, transaction activity to know when to lay-off the slack-fulfillment-capacity costs that are 1.5 to 2 times the lost margin total for an immediate profit improvement gain.
2) The B-D accounts that respond profitably to our new alternative marketing service, along with new minimum order size conditions, may grumble. But, on average they will buy 20 to 40% more due to more frequent and cost effective marketing attention. They will also increase their average order size and/or pay (higher) freight charges. They will all become profitable, or they will have to be demoted to “C” or “D” account service, price and terms just as frequent fliers are if they reduce travel. The increased volume will offset the lost margin dollars from the departed, but on a new profitability stream basis. And, the transaction activity costs for this second group will also drop creating yet more slack to lay-off or redeploy.
3) The two laid off reps’ total costs greatly exceed the cost of the new hybrid marketing person to yield an immediate cost savings to grow profits.
4) With the new comp plan, we immediately lower the sales cost as a percent of historical margin dollars being maintained.
5) And, the Best Rep captures another 20 to 100% more profitable volume from the new A accounts inherited from the weak reps within 3 to 9 months.
WHY ACT NOW? HOW?
Our current and likely-future economic conditions dictate that many distributors must stop trying to grow the top line without good CTS analytics that will in turn change sales force training and incentives. We need to stop the chronic bleeding from the three factors covered in this article and start paying reps in a bottom-line way which aligns them with management and their own long-term, economic interest.
If downsizing, upgrading, re-orienting and re-paying the sales force seems to be too overwhelming a challenge, then write down the reasons for resistance and discuss the underlying assumptions in light of:
- The math exercise above.
- What we are currently paying reps for the actual customer profitability in their respective territories. (Warning: many big hitters have net losses for the territories.)
- Where we are in our industry’s life-cycle. Territory reps on commission used to be prevalent in distribution channels which switched to “integrated sole supply” buying like drug, grocery, hardware and hospital supply. They were replaced by salaried consultants that lead replenishment installation teams. These new sales reps serve annual sales volumes that are typically 10 to 20 times greater than the old-way reps. Is our channel moving some percent of the way towards what the biggest volume channels have already done?
- What is our next best alternative plan to solve the problems identified in this article?
- Reviewing customer profitability reports every month and continue to score the losses from: biggest 1% losers; C and D customers; and each sales territory. Repeated exposure to and discussion about true customer profitability results builds new understanding and courage to act.
If measuring customer profitability to cure all three problems and to pay incentives on “positive delta PBIT” is an informational challenge, fear not. Any distributor can subscribe to Waypoint Analytics: a web-based, profit-play strategic information service that will allow instant analysis, tracking and re-compensation plus support with many more of my “radical profit improvement plays”. The service can be installed with 5 to 10 business days and return an instant, big positive ROI. Inquire about the next free, 1-hour webinar!
©Merrifield Consulting Group, Inc. – Article 4.11
- For a preformatted, excel spreadsheet into which you can plug your own numbers to do this sections calculations download article 2.31 http://www.merrifield.com/articles/2_31.asp ↩
- Paying reps on delta PBIT requires: a parallel reporting system to the ERP system that most distributors have; new solution plays like the one described in this article; and some new skills for transforming the most losing accounts into profitable ones. The Waypoint/Merrifield partnership solution provides all three. ↩