What have we learned from the past decade regarding managed inventory agreements? Have we learned from our successes and our failures? Are we smarter and wiser? Or, have we learned little, dooming us to repeat the same mistakes we made last year, five years ago and 10 years ago?

To answer those questions, we assembled a panel of respected experts, all of whom sport a lengthy resume in the areas of integrated supply, vendor-managed inventory and systems contracting. Each is battle-tested, and has the scars to prove it.

The panel includes Dick Decker, director of integrated supply for Industrial Distribution Group, based in Atlanta; Jim Narus, a professor at Wake Forest University in Charlotte, N.C., with expertise in industrial distribution; and Scott Benfield, director of marketing for Columbia Pipe & Supply in Chicago and an author/consultant to distribution.

Benfield served as the moderator and contributor for the article.

The forum took place recently over the Internet, as panelists provided their insight and commentary to questions e-mailed to the group by Benfield on behalf of Progressive Distributor.

The goal was to take a look at what the distribution industry has learned about managed agreements. Specifically, what did we know about the subject 10 years ago? In hindsight, were we on the right path? Did we truly know what we were getting into? And, did we set this valuable tool up for a substantial derailment?

The answers from our panelists showed that industrial distribution was both visionary and partially blind. For example, we correctly predicted a need to evolve to meet a changing world and a changing marketplace.

We knew that the competitive pressures would increase, says Decker. We knew technology would change the way we go to market. Driving out costs would start to become a priority.

Says Narus: We knew the importance of total quality management and ISO standards, and the need to manage and minimize total costs.

Adds Benfield, We understood the concepts and that technology had reached the point that it was possible to successfully streamline supply chains. Any number of supply chain consultants (Frank Lynn, Bill McCleave and Mike Hammer) had talked the concepts and it was not long before manufacturers began to demand these services from their suppliers.

Sounds pretty good, right?

But the panel admits there was plenty we didnt know.

In the beginning, most managed inventory agreements were still focused only on product and not process, says Decker. Partnering was just a word and not a practice. Process management and activity-based cost (ABC) models were starting to be utilized. I also do not believe many distributors saw the speed at which integrated supply would grow.

Narus says we got more than we bargained for.

There is a definite trend on the part of the customer to pursue one-stop shopping, he says. Senior management and Wall Street have placed considerable pressure on managers to achieve growth and profitability. As distributors rushed to provide value-added services, many quickly found they didnt have the ability to implement those services (basically, talk is cheap).

Moreover, theyve increasingly found that although customers want such services, they are often unwilling to pay extra for them.
As a result, many distributors find themselves offering allegedly value-added services that take them away from their core capabilities, add tremendous costs and provide marginal profits.

Benfield approaches the distributor financial and capability sides of the process by saying, Most distributors (especially smaller ones) were sending a local seller or branch manager to negotiate a seven-figure deal with the top financial and purchasing guys of a Fortune 500 company. Who do you think was better prepared to come out on top of the deal? Also, quite a few wholesalers had one or two large accounts that commanded a lot of their revenues. If the large manufacturers wanted to squeeze out a deal in their favor, and they knew their power over the local supplier, it was not hard to do.

Integrator, know thy costs
In general, the panel points to the need for a keen understanding of process costs. Interestingly, Decker and Benfield appeal for activity-based costing and management. Narus, however, goes beyond process costs and makes a more fundamental observation, pointing out that many distributors rushed to provide new services and either could not implement them or customers would not pay extra for them.

The observation that customers dont want to pay extra for services speaks to a lack of market research and preparation by distributors to fully understand customer needs. The problem is compounded by the intangible nature of services and the curious, but costly, practice of distributors bundling services with products, as opposed to unbundling products and making their services fee-based.

Some distributors now admit to accepting many unprofitable agreements. Their pricing models were product-based, but they lost money on service transactions. In hindsight, would it have been better for distributors to charge a fee for their managed inventory agreements? The panel agreed with that position, with some notable exceptions.

In general, firms neither measure value nor the total costs of providing an expanded service offering. They merely throw darts at these issues, says Narus. Those that guess right succeed and those that guess wrong fail. Not surprisingly, most firms guess wrong but no one ever hears about them in trade articles. I find very few companies (distributor or otherwise) have data to know which customers are actually profitable. If you dont know these numbers, how can you negotiate a profitable contract?

Says Benfield, I have seen very few of the larger deals that stand up to a good ABC cash flow analysis. I did a piece for this magazine (Sept./Oct. 98) that modeled a pro forma pricing of a mock agreement using weighted average cost of capital as a hurdle. I found many distributors had a very poor understanding of basic financial principles to judge the soundness of their pricing. If sellers cant provide their owners with a good financial analysis for accepting these agreements, they should get training to allow them to do so.

There was one distributor that I believed had cracked the code on service fees. He shipped all orders to the account direct. He controlled the tool crib and billed the customer for all of the operations to support it including labor, inventory management and bookkeeping. He billed process fees separate from product fees.

Decker agrees that some distributors entered into unprofitable agreements.

Probably the most compelling problem was inventory investment, he says. Obsolete (products) and specials were all dynamics that usually created unprofitable agreements. What most knowledgeable distributors are using today is a pro forma model and activity-based costing to understand the agreements.

The panel disagrees on what makes managed inventory agreements unprofitable. Narus alludes to poor measurements of value and costs, and differentiates between the two. Benfield refers to poor financial training and modeling. Decker, while mentioning ABC modeling, focuses on unique or obsolete inventory costs.

In a recent pricing seminar for industrial distributors led by Benfield, only 15 to 20 percent of the attendees said they utilize activity-based costing. Fewer still do any formalized service research satisfaction or loyalty which is the bedrock for measuring service value.

Many distributors, it seems, want the big business of managed agreements but are not willing to invest in new tools to measure their financial validity. An attitude of sell it now and worry about it later still permeates distributor pricing of these arrangements. The net result, of course, is that unprepared sellers take arrangements that are financially unattractive and often ruin their own financial health without proper evaluative tools.

What type agreements work? What types dont?
Successful agreements offer consistency with simple measurable processes and expectations, says Benfield. The more complex the arrangement with specialized needs, the more the probability of an unprofitable agreement. I would like to see more agreements that have documented processes and expectations that are based on fact, not windage. I do believe that successful distributors will strive to offer a template by market segment for these agreements.

Narus says he is unaware of any data to say one way or the other which types of agreements are working. Distributors are increasingly offering standardized service offerings, he says.

Adds Decker, I do not believe there is a clear-cut winner in what industrial customers are leaning toward. Execution of the agreement seems the most critical key to any form of managed inventory agreement. Distributors outsell their ability to perform, and industrial customers expectations are not saliently clear. As the marketplace matures, there is an offering of standard type services.

How will electronic commerce impact managed inventory agreements?

The auction environment will erode margins, says Decker. Industrial customers will lose textbook expertise and service from e-commerce. There will be a large learning environment on how to effectively use the Internet without eroding technical expertise and service.

Benfield believes e-commerce will initially bring transaction costs down. But, he warns, transaction costs are not product costs and need to be measured and priced separately to price them correctly.

Adds Narus, E-business (and not just e-commerce) is facilitating
supply chain management. Better margins will go to whoever manages the inter-firm supply chain management system. If it is the distributor, their profits will go up. If the customer manages the chain, the customers profits will increase.

The panel agrees that prices will go down, but for different reasons. Benfield and Narus point to cost decreases (process efficiencies), while Decker believes auction pricing due to greater price shopping will bring costs down.

The cost savings for e-business are real and will be reflected in lower purchase prices. Decker, however, has an interesting concern. He says end-user customers will drive down product price but want the same service for technical support.

The ability to shop product price will increase, but what about valued services? he asks.

Crystal ball gazing
Moving forward, it will be increasingly important for distributors to unbundle services from products. Products will sell for less than they sell today, but services selected by customers will be tacked on. In other words, customers can buy the product for less, but if they want technical support, expedited shipping, application advice, special ordering, etc., they will have to pay extra. There also will be a need to market value-added services and receive fee income from their consumption.

Finally, the last two questions asked panelists about successful agreements of the last decade and what type of training should cover future arrangements.

Training will revolve around several areas including: financial analysis using activity costs, an ability to flow chart and cost processes, and an ability to assemble and manage a project team will all be needed to manage the agreements in the future, says Benfield.

Narus sites Graingers integrated supply model as one of the more successful fee-based models.

I think that W.W. Grainger is on top of such service offerings, he says. They seem to be the most innovative and successful at this point in time. Training should be offered on service cost management.

Successful agreements all have senior management ownership,
says Decker. In the future, compensation will be tied to productivity (saving the customer money) and profitability. Employees will have to train their associates in process management.

While managed agreements of one sort or another have been the rage, many have involved cost shifts from customer to distributor to distributors vendor. Lasting supply chain improvement is a difficult and arduous task. Technology, education, rethinking what distributors are selling (service vs. product), and proper management tools (ABC, discounted pro forma analysis, service research) are things distributors must perpetuate from the past to help define a more profitable future.

Scott Benfield is a consultant to distribution. He has written two books for the National Association of Wholesaler-Distributors and also works as a marketing executive for a top 50 U.S. distributor. He can be reached at , or .

This article originally appeared in the May/June '00 issue of Progressive Distributor. Copyright 2000.

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