Team Up! Profit Up! Partners in Channel Cost Reduction

Tim Underhill

Team Up! Profit Up! Partners in Channel Cost Reduction

By: Tim Underhill

Customers have always approached their suppliers in an effort to reduce the price they pay and to have their suppliers perform additional services. But the last few years have seen a significant increase in the pressures customers are applying on their distributors for these reduced costs. And this trend is growing.

Not just because someone in the market always seems to agree to the customers demands, encouraging them to ask for more. But because the pressures on the customer's profits continue to increase, and the cost of goods and services offers them the greatest perceived potential to reduce costs.

The Center for Advanced Purchasing Studies (CAPS) estimates that on average 55% - 65% of the customer's revenues goes to the purchase of goods and services, and in one of the studies by CAPS, the VP of North American Purchasing and Corporate Affairs for Honda Motor Company estimated 80% of the cost for building a car was purchase costs. This makes the target of price paid for goods and services very attractive if a company wants to improve their profitability.

But price is not the only opportunity for customers to reduce their costs. In a recent study conducted for the Distribution Research and Education Foundation (DREF): Team Up! Profit Up!, it was found that customers were undertaking over 187 different initiatives to improve their profits through their suppliers, of which 65 were common across multiple industries. These initiatives included opportunities to control costs in seven major categories:

1. Expenditures
2. Performance
3. Inventory
4. Administrative Costs
5. Engineering Support
6. Information Sharing
7. Quality Control / Safety

And for customers pursuing these initiatives the results have been significant. The Supply-Chain Council, a group of companies that share best practices and financial data on supply chain costs, estimated companies actively pursuing supply chain management as a strategy for reducing costs have been able to increase profits by 3% to 7% of revenues.

But what happens when things bottom out? What happens when the customer cannot find additional opportunities to reduce costs with their distributors? Eventually that has to happen, because suppliers cannot continue to provide more services and reduce their pricing. Nor can distributors continually turn to their manufacturers and ask for additional price concessions when confronted by customers that demand a lower price. Eventually both distributors and their suppliers will come to a point where they cannot give any more. So what will the customer do?

They will find an alternative. They have to. The pressure is too great not to. The most recent alternative is off-shore purchasing, and while there are risks, there are significant opportunities for price savings. And some customers are finding a 15% price reduction opportunity for some power transmission products (after accounting for shipping).

The probability that the price paid for goods could be reduced by 15% seems unlikely to some distributors not faced with such competition. However, others are already feeling the pressure and looking for ways to streamline their operations. But internal costs are only part of the cost reduction opportunity. The 1998 DREF report: Facing the Forces of Change found that 25% of the costs in the channel are redundant. If customers could eliminate this redundancy, then they could possibly achieve a lower price.

Of course in doing so the customer may lose the value provided by distribution, but most customers do not know what that is worth. They do know how much they will save if they find how to reduce these costs and receive a lower price. There in lies the problem.

Customers will find a way to reduce their costs. Maybe by using e-commerce. Maybe by going direct. Maybe by going to overseas sources. All have their own set of problems and costs. But they also offer the customer cost saving potential. If Wholesale-Distribution as an industry does not find the answers on how to reduce these redundant costs and become an even more efficient supply chain, the customer will. And in such cases it usually is not to the liking of the distributor or the manufacturer.

Good News / Bad News

The good news is many distributors and manufacturers see the need to work better together to make the distribution channel more efficient. In fact, Team Up! Profit Up! found that 90% of the distributors and 83% of the manufacturers saw the need to work better together to reduce costs as either very important or extremely important. But the bad news is that both these channel companies also felt they did not have the time to work on these costs.

The result: we try to accomplish improvements on our own that can in some cases cause problems for the other company. For example, distributors are trying to offer more products to their customers and improve the profit ratio on sales per order. But additional lines means less focus on a specific manufacturer's products, sometimes resulting in lost market share. In an attempt to recover this lost market share the manufacturer then adds on additional distributors, further diluting the distinction the distributor brings the customer. Or the distributor reduces inventories in an effort to cut costs. But this dilutes the value they provide manufacturing and can drive up the manufacturers' cost to have product available to meet customer demands.

In effect the value each channel partner is adding to the other is diluted and the cost savings for one is often a cost to the other. The bottom line is that we need to determine how we can work better together to reduce the costs in the channel for our mutual benefit.

Getting Started

Getting started is often the toughest part of any change. Time constraints, other initiatives, concerns over ability to find a channel partner willing to work with them and a host of other reasons, all make taking that first step very difficult. But with so many distributors and manufacturers knowing they need to work on these issues, somebody will take that first step.

And when they do, they have the potential to create a real competitive advantage: a more cost effective and efficient supply chain. Exactly what the customer needs and in a manner that can make both the distributor and manufacturer more profitable and competitive. So for those companies looking to get started here are the steps to take:

1. Supply Chain Initiative Evaluation: The first step is for both companies to look at the pressures they are facing on an individual basis. What concerns do they have? Where are the greatest costs they incur? Then they need to determine if there are opportunities to work with their channel partners to reduce these costs and accomplish their goals together.

2. Identify & Approach Key channel Partners: Companies desiring to implement this should not try to do this with every supply partner. Instead, identify one or two companies with whom you are willing to work. The selection should be based on the impact the supplier has on your costs / sales, their willingness to work with you, and a strong existing relationship.

3. Evaluate Options Together: Once you have found a company to work with you, look at both their needs and yours. Find opportunities that make sense to both. Finding common ground overcomes a lot of barriers. After some success, companies can tackle harder issues.

4. Create a Joint Improvement Team: Any opportunity that is pursued needs to have someone with ownership for accomplishing that initiative. The team should consist of personnel who are affected the most by any changes made in either company. This team can be very advantageous, both as the means ensuring the initiative is pursued, but also as a means for getting input and support from those impacted by the change.

5. Create a Joint Operating Structure: Simply put, how is the team going to operate? How often will it meet? How will it resolve problems that develop? What authority does it have to make changes and to secure resources?

6. Develop an Improvement Plan: One the team is in place, they should look at developing an implementation plan. A step-by-step determination of what they are going to do and how.

7. Manage the Change: In many cases people will resist the change. The team should be responsible for helping to implement the improvement and overcome any obstacles during implementation.

8. Evaluate the Results: To often changes are made without determining their effect on the organization. The team should perform a cost / benefit analysis to ensure the change was an improvement, and to adjust the implementation accordingly.

Working together to reduce costs and improve operating efficiencies in this way may take time. Yet as more and more of the products and services provided by distribution are being treated as commodities, making it harder for companies to distinguish themselves, the need to pursue these opportunities only increases. And working the supply chain to make it an even most effective channel for our customers can provide both the distributor and the manufacturer a competitive distinction: lower costs and great responsiveness.

But is this just "pie in the sky"? Ask your customers. They're finding supply chain integration as one of the largest opportunities to improve their profits and their customer satisfaction. It is one of the reasons you are seeing so much attention from them on this. Shouldn't you be looking at these opportunities too, and help shape the direction these changes will take?