81. Find (and Fill) Your Cross-Subsidy Fault Lines

Want to expose the ways you in which you can beat Amazon (AMZ)? Start with a line item cost-to-serve model for your distribution company or for several of your most innovative distributors. Then, create profit and loss rankings for every SKU and vendor, as well as for customers, territories and niches. Get ready for some shocking revelations. The biggest: big profit/loss cross-subsidies fault lines likely exist between your most profitable and unprofitable customers and SKUs.

The most profitable warehouse items:

  • Are popular (highly picked) commodities
  • Have high-dollar sales per pick averages
  • Have margin percentages that seem low but gross profit dollars (GP$s) per pick that exceed the cost to serve dollars (CTS$s), yielding the highest profit dollars (P$s)

Another way to think of this is using the Profit Equation: GP$s (-) CTS$s = P$s.    

Notice, there is no gross profit percentage in the Profit Equation. Believing that high gross profit percentage items are profitable makes you blind to the huge variances in average sales per pick and the unknown cost-to-serve dollars. You’ve got margin myopia!

The least profitable warehouse items:

  • Have lots of annual picks
  • Have small-dollar sales per pick averages
  • Have high margin percentages (GM%) but big GM% times small-dollars per pick yields a GP$s/pick that is too small to cover the larger cost-to-serve dollars per pick, yielding a profit loss

Distributors typically lose money on about 70% of their line item profit equations. This can be made up with profitable direct shipments and warehouse cream SKUs. But, then enters the profit-skimming wolf!

Amazon’s contrasting pricing and terms

Amazon and its resellers ignore traditional channel markup patterns. They discount the cream items to make a small profit, not a killing. Customers increasingly use the AMZ app to check distributor prices on popular higher priced items. Then, they spot-buy the cream item for less from AMZ and order the losing picks from the distributors. Why split orders and give you the littles? It’s all about the math!

Amazon’s approach to the littles:

  • Requires you to buy a bundle of small-dollar items rather than one
  • Charges higher prices on the littles than your list price
  • Classifies many littles as add-on items

In contrast, magnanimous distributors offer contract prices on entire lines (including littles), one-stop shopping on the littles, no minimum pick or order size, free freight and free restocking.   

How did we get here and what are the next step trends?

What root causes permit private label clones (of the creamiest items) to be equal or better in quality than the original, at lower prices and still be profitable to a seller? Why, conversely, do brand factories hugely overprice best sellers? It’s a forgotten evolutionary story!

It started when channel pricing formalized the list price less mark-up schedules during WW2 shortages for simple vanilla product lines. Then came the over-extension of product lines. The bottom 50% of product variations sell poorly, but are priced the same as vanilla. Authorized channel partners had to stock the entire line.

So, vanilla was invisibly making excess profits to pay for the losers. Since all resellers played by the rules, 100% of overall sales yielded 100% of overall profits. Because of logistical barriers, clones were unable to logistically get shelf space or marketing attention. Factories kept creeping up their brand loyalty tax on the entire line, helped by customer habit, conformity and lack of clone information. In some channels, when big box stores got branded lines, they only stocked and discounted the movers, while introducing store clone brands. Traditional retailers lost their cream and died.

So, what’s changed now? Lots! Now there is:

  • Unlimited cyber shelf-space
  • On-line product information and customer reviews confirming that creatively packaged and new-branded clones are as good or better than #1, for less.
  • A next-generation of digital-addict buyers willing to experiment on new brands
  • Brilliant execution of AMZ’s new logistical infrastructure

This all means that brand loyalty, market share and pricing power are eroding. So, what should factory honchos do?

  • Go where next-generation eyeballs and the fastest growth are: Amazon Business
  • Take charge of content management branding, which is rapidly going to multimedia
  • Sell the best items at lower prices on AMZ to keep clones at bay and minimize gray market resellers dumping and discounting their brands
  • Raise prices or discontinue losing line-extension SKUs
  • Determine precisely where and how to harmoniously, disintermediate and re-intermediate legacy channel partners

Could we see AMZ private label? The best vendors go direct to AMZ? Or, channel reinvention?

Disruption from digital product information and AMZ’s new delivery infrastructure are here, and their effectiveness is accelerating. Highly-evolved, legacy distributor models are too rigid, costly and mispriced. And, the biggest brands with the historically best distributors are the most vulnerable.

The Solution: Factories need to share SKU profitability data with their most progressive distributors to agree on where the cross-subsidy fault lines are and find a new way forward together.

Leave a Reply