Of bean counters, recession, 
service quality and cost hacking

by Scott Benfield

Distributors looking to cut costs in order to weather the recession often begin by reducing head count. Before making cuts, managers must be careful not to hurt service quality.

It seems the economists can finally agree on one thing, and that is, we are in a recession. The duration and severity of the contracting gross domestic product (GDP) is unknown. One thing that is certain is that distributors will be affected by the contracting economy right along with most U.S. businesses. Because of their perennially low profit margins, wholesaler-distributors can’t afford to suffer a substantive sales and margin drop, or they will go in the red. Unlike the manufacturing sector, however, wholesalers have many variable or semi-variable costs they can shed in tough times.

What to get rid of in a downturn is not as easy as it seems
Most wholesalers spend 60 percent to 70 percent of their expense dollars on people. These people perform a variety of operations, from buying, receiving, storage, picking, shipping, payables, receivables, warranties, returns, inside sales and outside sales. The vast majority of these operations are awash with mind-numbing, high-volume paperwork or data entry. The people who do this work aren’t high-ticket managers, they’re generally lower level to mid-level managers who are on the front lines every day.

This labor pool is one of the most crucial factors to distributors. Why? Because the rote, high-volume paperwork is the most basic, expected service core of the business. Without a reasonably reliable core of basic services, the wholesaler probably wouldn’t be in business, and it is the lower level processor who does this work.

Beware costly mistakes
In a recession, wholesalers typically look at head count expenses to start their cost hacking. It seems logical, after all, to cut the bundle of expenses that are the largest. But, just because it makes sense from an accounting view, it largely negates the service value provided by the rank-and-file, and the link between service quality and income streams.

In other words, the mundane, data-heavy processes done by the large labor pool are crucial to maintaining service quality. Cost-hacking of service providers can backfire.

Consider an experience with Greenville Supply (name changed) that looked for advice on a “sales” issue with major customers. It seems Greenville Supply had been through a mild recession. A year later, when the economy was booming again, Greenville’s sales were still soft.

Reviewing the sales management and operations, I found that part of the business was above average. We conducted service satisfaction research for Greenville to give hints on any service problems. The areas of credits, warranties and returns had a high level of customer dissatisfaction.

Delving further into the research, we discovered that in the prior year, when business was soft, the accountant cut his staff, especially those responsible for customer credits, warranties and returns. It seems Mr. Bean Counter had done some ratio comparisons within various departments (cost of department labor to output ratios) and found that he had an inordinate amount of people in his credit area. He promptly hacked head count costs to be in line with other wholesalers.

What Mr. Bean Counter didn’t know was that he had a lousy credit process that was 40 percent more inefficient than the wholesalers he compared his company against. Ratio analyses on head count costs don’t measure process inefficiency. When Greenville lopped off heads in the credit department, its credit turnaround went from two weeks to more than six weeks. Customers with credit disputes weren’t getting them solved in time. Since their complaints to the credit department weren’t being answered, they began to take their business elsewhere. And, of course, all of this cascaded into a sales problem well into the next year.

The gist of this story is to remind wholesalers to use caution when cutting heads on customer-sensitive processes by using ratio analyses. Without diagramming the process flow and taking out redundant process steps, cutting heads often cuts service and drives away customers. It is also important to measure the importance of the service to overall customer satisfaction. Those services that are most important to satisfaction should be handled with the most care. Make cuts only after detailed analysis.

In a recession, it is tempting to cut the cost of labor — but be forewarned — today’s cuts can be tomorrow’s revenue loss from poor service. If you are tempted to cut service costs in your business, there is a better process than hacking the cost.

Service measurement
In order to understand service quality, it must be measured. My favorite instrument for this is satisfaction research that uses “Derived Importance” ranking of services to overall customer satisfaction. Good satisfaction researchers also plot the relative perception of service quality compared to the competition. Satisfaction research can be done for under $50 per survey, and a sample of 25 to 50 responses can offer valid information.

After the satisfaction research, you should document the process flow and plot the time and cost of each process step. Once the flow chart is complete, you can rearrange it to take out redundant steps, ensure quality and reduce labor costs.

Finally, before rolling out a new service, it is a good idea to experiment with it to see if the customer is getting the quality they demand. Experimenting with the service also gives you the chance to rework the process and limits the risk to a defined sample of customers, instead of putting a bad service forward to your entire customer population.

Once you learn this method of service improvement and cost reduction, you can improve services and streamline costs with less risk of driving away customers and their sales dollars.

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