The rise of the transactional distributor

Research shows that it may be time for distributors to consider a new, low-cost service model for some customer segments.

If you have been reading the recent research about the value of outside salespeople in Progressive Distributor, you may be uneasy about the future. Why? Essentially, the research points to a large overcapacity in outside salespeople. How much overcapacity is unknown, but from our research, 30 percent to 40 percent is not uncommon. The upshot of this research is that there will be fewer outside salespeople in the future in distribution ranks.

While many salespeople debate the research and its outcome, the prevailing evidence is, for many customers, fewer value-adding outside salespeople translates into more value. Of course, this smacks of heresy in the sales-driven ranks of distribution where outside salespeople turned corporate officers dominate.

At the risk of excommunicating ourselves from the customer base we serve, we are content to chronicle, explore and help develop new models of sales allocation and new models of distribution. These models will be explored in further research to be conducted by ourselves and by Progressive Distributor. Until then, it is appropriate to begin opening our minds to what models of sales allocation and distribution are likely to dominate. Ample evidence exists that many of these models are underway and the Transactional Model is one of the most disruptive and powerful.

What is transactional distribution?
Simply put, transactional distribution is the streamlining of the distribution firm to appeal to economic buyers. Economic buyers are those that want the consistently lowest cost with reliable but limited service. If you are looking for evidence of transactional firms, read up on the history of Nucor Steel and Southwest Airlines. These businesses ran contrary to traditional models at Bethlehem Steel, U.S. Steel, American Airlines, United Airlines and the like. One only has to read recent business pages to know where these firms are vs. their counterparts.

What Southwest Air and Nucor Steel did was — and is today — highly unique. They essentially took an outside view of a mature industry and rearranged their processes to lower operating costs. For instance, instead of huge, fully integrated steel mills, Nucor developed specialized mini-mills that drove productivity through billet tons per hour. Southwest Air, now entering its third decade, decided that customers really wanted to primarily get from point A to Z in the least amount of time, and at the lowest cost.

Assigned seating, first-class passage and flight attendants dressed to the nines didn’t matter all that much. The company essentially rearranged the traditional service offerings, took the cost out, filled the galley with lower-priced fares and lapped market share from the high-cost, bloated competition.

The lessons from these companies can be translated to distribution. The models are not entirely accurate or applicable since distributors serve many niche markets with specialized needs. For the larger segments, however, Transactional Distribution could conceivably take an enormous share away from the existing distributor base.

Taking cost out and limiting flexibility
Controllable costs in distribution are largely found in operating expenses. Traditionally, distributors have focused on the cost of goods as evidenced by their dependency on co-op buying and sophistication of the inventory management systems. Operating expenses, for many vertical distribution industries, have not been effectively reduced for three reasons.

1) First, to correctly reduce long-term operating costs, processes have to be documented, streamlined and changed without effecting customer satisfaction. This takes skills in process documentation, process streamlining and satisfaction measurement. Without understanding how services affect customer buying habits, how does one reduce long-run expenses and not lose business? Remember that 50 percent or more of end-user buyer decisions are done on the basis of service. Unfortunately, in distribution ranks, it is all too common not to see process documentation, process reorganization and satisfaction measurement of the new service. And this feeds our observation that many distributors have not effectively reduced operating expenses.

2) Distributor measurements are accounting driven. Financial metrics are superficial indicators of performance and often lead to wrong path solutions. Consider the plight of the distributor that, through an informal group, decided that the number of people in the accounting department was high for the level of sales. The CFO reassigned or released workers in the department to be in line with group peers.

The result was that customer credits went from two weeks to six weeks to process and some major customers defected. In addition, his action severely aggravated an already acute cash flow situation by increasing the cash flow cycle by some 30+ days. The CFO never considered he had a poor process that required more labor. Essentially, he cost-hacked expenses using an accounting comparison of headcount-to-sales for his accounting department.

Accounting numbers are only a start for performance benchmarking. Distributors need to find better numbers to target operation-specific performance, and the role of accounting for internal benchmarking will take a backseat to activity costs or operation-specific benchmarks.

For example, we have found that many distributors don’t know their shipping capacity. Consider the case of Distributor M that had 50 trucks on the road at a cost for the truck and driver of $80,000 per year, or an aggregate of approximately $4 million. The maximum deliveries that could be made in a day was 17. Multiplied by the number of trucks (50) and 252 working days, the company had a maximum capacity of 214,200 deliveries. 

The distributor made 140,000 deliveries per year or approximately 65 percent of capacity. The resulting analysis showed $1.4 million (35 percent of $4 million) in assets not being used. What happened? Salespeople made delivery promises by transaction or by customer, which caused the distributor the ability to fully load trucks.

This example happens to any number of operations in the distribution firm and is largely a result of letting salespeople make capacity decisions without a clear understanding of their consequences. Activity costing has consistently shown that to maximize capacity, you must fully utilize assets or spread them over large transactions. With salespeople offering service flexibility, there is no consistent company strategy to maximize service capacity, lower costs, and propel it with a low price.

Marketing strategy, operations 
fulfillment, and transactional distribution
The starting point for transactional distribution is marketing. Marketing’s job is to determine which customer segments are willing to absorb limited flexibility and streamlined service for a low price. There is a bit of the chicken and the egg problem in this, however, since it is almost impossible to sell a limited-transaction/low-cost model without building it. Therefore, operations and marketing must work hand in hand from the get go to find out which services are not needed or can be eliminated. 

The type of questioning in our sales value research is a start. In essence, economic buyers could do without outside sales if they had a catalog and a solid inside sales function. Other service tradeoffs need to be examined in the light of delivery, debt carrying, credit resolution and e-commerce. Once the tradeoffs are examined, marketing and operations can begin to build and experiment with the feasibility of transactional models.

From our research, the following areas are suspect to reduction or streamlining for large customer groups:

• Outside sales at an average cost of 3 percent to 5 percent of sales.

• Inside sales at an average cost of 4 percent to 6 percent of sales.

• Delivery expediting at an average cost of 3 percent to 5 percent of sales.

• New product specialists.

• Excess choices in brands and product options.

In transactional distribution, the idea is to give a plainly stated, limited service offering. In essence, a possible service platform could include the following:

• Order by catalog or online with limited assistance.

• Standard terms, 10 days, no discounting.

• 24-hour delivery with expediting done by an outside service for a fee.

• Little to no inside or outside sales assistance.

• Limited product offerings in depth and width.

• Standard fee for returns from wrong customer orders.

The model detailed above could conceivably take 7 percent to 10 percent out of operating expenses, the majority of which, when passed along to the customer, would minimize the fixed or step costs and perpetuate the low cost to market.

It looks good on paper but . . .
The transactional model is not prevalent in distribution circles. Why? There simply has not been the need and the push from customers to lower the cost base. Our sales value research indicates this may be ending. Many customers are no longer willing to fund the large operating expenses to keep salespeople around “just in case.” Customers also quickly understand the proposition of a transactional offering. When offered the choice of an outside salesperson, on a fee basis, more than 50 percent of the survey respondents agreed with the idea. In short, customers understand the idea of service for a fee, but distributors have difficulty developing the offerings.

Some of the problems in transitioning to a low-cost service model are cultural. It is difficult to change a full-service culture to focus on cost and limited flexibility. Distributors are often ingrained in past models of business to the detriment of new ways of conducting business. Culture is osmotic and subconscious. In short, it is absorbed and not often analyzed, which means that change must come from the mind first, which is difficult to do. The plight of competitors to Nucor and Southwest attest to the difficulty of changing the mindset from an ingrained full-service model to its low-cost counterpart.

A living distribution example of the difficulty to change is industrial distributors. These distributors, who serve industrial OEM and MRO customers, have responded to the managed-inventory needs and cost-sensitivity of their customers by championing the “value-added salesperson.” The moniker is an attempt by industrial distributors to sell more product and service value to customers and receive a greater price. In our view, the strategy has backfired, with value-based selling amounting to ever-greater service given to customers who take it for free or who didn’t want it to begin with. The result earnings of 1.3 percent before taxes and some of the biggest and brightest former stars filing for bankruptcy.

In essence, the old model and culture were so ingrained that many industrial distributors tried to sell more value when the customer base was screaming for fewer services at a lower cost. They literally added sales value, which the customer would not pay for, to the point that their profits are slightly better than treasury securities.

We believe that successful transactional distributors will be standalone start-ups that spring out of existing distributors. The more sophisticated and cost-savvy will begin to measure service costs, experiment with their operations fulfillment and develop new business models that take the cost advantage to market. It is likely that the most successful models will not be add-ons to the old business platform but new ways of doing business with different management and a culture of taking the cost out.

To our pleasure, some distribution industries have collapsed the old cost structure to serve a high-volume/limited-service customer base. A growing group of electronics distributors serving large OEMs have developed a low-cost model of doing business where they make sufficient profit at 9 percent gross margin vs. the prevalent 18 percent to 20 percent or more in other vertical channels. They essentially analyzed their costs, reduced the services that were not needed or not valued, and lowered the price to maximize capacity.

Of course, transactional distribution is only one model of business. But, current research says that a significant group of customers no longer appreciates the cost of salespeople and full-service offerings. They would be much happier to place their orders online, get a reasonable delivery, limited flexibility and a much better price.

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