In our last “Strategic Insights”, we recommended the book, Islands of Profit in a Sea of Red Ink by Byrnes.¹ This must-read will inform your management team as to why most distributors have big, profit-loss, cross-subsidies existing between both customers and items. And, it will guide you in applying “precision supply solutions” to grow customer value, lower “cost to serve” (CTS) and grow sustainable profits enormously! The cross-subsidy opportunities are invisible for several reasons:

1. Distributors typically measure “profitability” of individual customers/items based only on sales, margin dollars and margin percentage levels by default. Does your firm know the CTS for processing every line item scenario to then subtract those costs from margin dollars to determine the net-profit contribution for a specific customer or line item?
2. If CTS is unknown, then all sales, margin dollars and customers are “good”. They help to cover “fixed costs” which are typically unmeasured and over-estimated.
3. A database of many different types of distributors using net-profit management reporting reveals “fixed costs” to average about 20% of all costs; 80% are variable.² “MORE: Sales, margin dollars, rebates” blinds us to asking where are the “economies of scale”? There is no correlation between distribution-location sales (or margin dollars) and pre-tax return on inventory and receivables?
4. Most companies have one main, historic way for going to market. If it is with outside sales reps, then a mature, distribution location has usually accumulated many, small, never-growing accounts. The standard-service-model CTS for these “house accounts” will typically exceed the margin dollars per transaction from the accounts for an average loss on every order. These accounts need a new “service model”.
5. At the other extreme, the top 1%+ of the most-profitable accounts – which on a lifetime, net-present-value basis generate over 20%+ of profits – are typically underserved by an assigned rep. Will you or a competitor be the first to focus a team effort on these (prospective) profit giants to co-create a next-level, win-win, precision-supply-chain solution with extra budget resources?³

WHALE CURVE PROFITABILITY REVELATIONS⁴

Distributors who have out-sourced the challenge of CTS modeling to Waypoint Analytics are quickly and affordably getting profitability ranking reports (and 200+ other tools) via the net. What is initially most informing? By studying the “peak profits” on the whale curves for customers, items and suppliers you will see that all three far exceed reported financial profits. For most distributors, 20% – 40% of all customers are profitable and generate about 150% of the financially reported net profit total. The biggest-losing 1% will destroy 20% of those peak profits. Item profitability is far more skewed: 5-20% of the active (had 1 or more picks in the past year) items will generate between 200-800% of the financial profit line.⁵

Deeper-analysis tools for each section of these whale curves will then point to “precision supply solution” tactics that will increase the profits of each section to greatly surpass the “peak profit total” on the customer profitability curve (about 150% of financial profits).

THE OPPORTUNITY-COSTS OF SELLING “ALL-TO-ALL, One Way”?

Most distributors could at least double sales by selling the right half of their current active accounts the right, precision-supply-chain way and quadruple financial profits by using Waypoint profit-improvement plays. These plays all have tracking reports which in turn tie into “net-profit improvement reports” which allow every employee, including reps, to be incented on net-profit (turbo-charge an ESOP!).⁶ The plays achieve the following objectives:

1. Selling 20%+ more sales to most profitable core customers to boost their profits by 40%! (?)
2. Selling 20%+ more volume on most profitable items from most profitable suppliers for another 40% net-profit-improvement, flow-through effect.
3. Cracking and partnering high, profit-growth target accounts.
4. Changing the service model and terms for small, growing-nowhere customers. Half may leave to paralyze competitors, the rest buy twice as much on a profitable basis.
5. Turning super-losing accounts into profitable ones that then buy 20%+ more for huge profit swings.
6. Defining service metrics for a re-fined “service value equation” for each target niche of customers and allowing every front-line employee to get engaged in improving: service value, profits and their own, believable, measurable gain-sharing bonuses.

Request a go-to-meeting demo from Waypoint for your management team to at least benchmark what you may not be doing in value/profit improvement analytics. And/or, request an invitation to the Waypoint-sponsored “Advanced Profit Management” conference this fall in Chicago.

Strategic Insights # 8

©Merrifield Consulting Group, LLC

bruce@merrifield.com