Industrial distributors spend a great deal of time creating value-added products and services for customers. But they often devote very little time to capturing that value and charging customers. A book on pricing by industry consultant Scott Benfield aims to change that.

Prior to launching his own consultancy, Benfield spent more than two decades in the plumbing, heating and air-conditioning industries, serving in various sales and marketing positions for manufacturers such as the Kohler Company and Copeland Corporation; and for wholesaler-distributors such as Ferguson Enterprises Inc. in Newport News, Va., and Columbia Pipe & Supply, headquartered in Chicago.

“Capturing Value: A Guide to Strategic Pricing for Wholesalers” is the third book Benfield has authored specifically for wholesaler-distributor managers. Previously, he wrote “Marketing Plans for Growing Sales” (1997) and ”Services That Sell” (1999), both published by the National Association of Wholesaler-Distributors. Benfield also is a regular contributor to Progressive Distributor (click on stories at right).

The following is an interview with Benfield.

QUESTION (Q): Pricing management is as old as wholesaling. Why is now a good time for a fresh look at this function?

SCOTT BENFIELD: There are many reasons, but let me give you two of the most critical. First, most distributors have very loose pricing systems. Essentially, sales managers let their sellers — their inside and outside sales personnel — set price in most situations. In fact, they actually pay them to cut price. Why? Because they assume the sales person knows all about the cost structure of the firm and how these costs move, and therefore how to use a marketing template in strategic pricing. The fact is — and this is supported by research — sales-driven pricing ends up at the low end of the scale. There are numerous reasons for this, including a lack of financial acumen, poor understanding of how to base pricing on customer — not product — segments, and a compensation system that rewards on top-line sales or gross-margin dollars, not bottom-line dollars. Simply rewarding sellers on activity profits [sales minus cost of goods sold minus the specific costs of servicing a specific account] would correct much of the problem.

A second important rationale for this book is that one of the most common methods of pricing for distributors, called velocity pricing, typically doesn’t work. Velocity pricing is predicated on product movement: the faster a product moves — that is, the more sales it generates — the smaller the margin it yields. This makes sense, until you realize that all customers don’t buy products at the same rate. A slow-moving item with a high margin for one account may be a fast-mover with a necessarily low margin for another. In short, instead of looking at product movement, a wholesaler should first segment his entire customer base. Then he can determine velocity movements for these individual customer segments. The book discusses how to do that.

Q: Why don’t more wholesalers have managers, directors or even vice presidents whose No. 1 responsibility is to set and monitor pricing policy for their companies?

BENFIELD: Because most of them don’t understand the complexity of the pricing function and the positive impact a strategic approach to it can have on bottom-line profitability. That and the fact that most are content to leave the job to their sellers.

Distribution is primarily a variable-cost business: costs move up and down with sales volume. But too many owners and managers tend to manage their businesses as if costs were fixed. The implications for pricing policy are profound. If costs move up or down with volume, the strategic objective is to maximize gross margin [sales volume minus cost of goods sold], while maintaining sales volume. But by thinking costs are fixed, distribution managers cut price just enough to cover costs, plus a little more. In doing so, they essentially diminish pre-tax returns, because operating expenses actually rise with volume, even if their product costs fell because of bigger buys. A simple price increase of 1% in a 3%-before-tax business has the top-line sales equivalent of $33. This is a 33:1 leverage on assets! There is only one other place in distribution — cuts in operating expenses — that offers this kind of payout.

Q: As you have been here, your book is skeptical of wholesalers who yield pricing authority to their sales forces.

BENFIELD: Marketing’s aim is to build bottom-line profitability; sales aims for top-line volume growth. Distribution has been and remains a relentlessly sales-intensive business. Most distributors are content to sell like hell and count the spare change at year-end. It is a terribly old and inefficient model compared with what an emphasis on marketing can offer — studying the actual needs of discrete customer segments; customizing a full marketing mix to these various segments (product mix, service mix, pricing and sales promotion); establishing a pricing matrix that reflects the costs of the services these various segments need; and only then letting the sellers hit the pavement — if the customer even needs a sales call.

Q: But couldn’t a seasoned sales representative who knows his local market bring a great deal to this "marketing" process?

BENFIELD: Perhaps, but in my experience, it doesn’t happen often enough. When a seller says he "knows" his market, a wholesaler’s pricing and margins are probably in big, big trouble. What he "knows" is how to match a competitor’s price on a handful of fast-moving commodities. But most distributor pricing strategies must encompass 30,000 SKUs [stock-keeping units], backed by a good customer-segment logic and valid statistical comparisons of customers within a given segment to maximize margins. For how many of those 30,000 SKUs can your average seller really "know the market"?

I look at distribution today and ask: Why all the sellers? Whether it’s plumbing, electrical, heating and air conditioning, mill supplies, whatever, the products are mostly commodities. The ones that aren’t are pseudo-commodities on old product platforms. Why throw a seller, no matter how experienced and talented — and especially if he is experienced and talented, because he likely carries a heavier cost load — at a product that every customer in every territory already knows about? Distributors are so confined by their in-bred sales cultures, they keep sellers around "just in case." They look like those gasoline stations of a bygone era, where the attendant ran out, pumped the gas, washed the front window, checked the oil, and made change. That model gave way over time to self-service paid for with credit cards at the pump, because the typical customer was no longer willing to pay for the attendant’s services. The same thing is coming to wholesaling, regardless of the commodity line.

Q: I don’t think you’d get a big argument from the vast majority of wholesalers on the dangers of letting the sales force "give away the store." But aren’t most wholesalers so well-schooled in — and well-scarred by — these problems, that they’ve become absolute fanatics about their pricing and margins?

BENFIELD: I don’t agree. Beyond looking at the fast-movers, pricing inevitably gets less time than any other function — sales, operations, accounting, you name it. Managers spend their time creating value, or at least what they perceive to be "value," for individual customers. But they devote comparatively little time to capturing value through a strategic, systematic approach to pricing. Too many dollars are being left on the table by too many wholesalers, to the detriment of their already meager bottom lines.

Q: Wholesalers regularly complain about tightening margins and shrinking after-tax profits as a percent of sales. But haven’t most of them done pretty well over the decades, particularly during the 1990s, without a whole lot of marketing?

BENFIELD: It depends on what you mean by "well." During the 1990s, pre-tax profits for industrial distributors declined from 1.9% to 1.7%, and this was after they took operating expenses down a considerable amount. You would find similarly depressing trends in other wholesale fields. You and I could get a better return on an index fund than the average wholesaler’s 2% pre-tax, and we’d also have greater diversification and liquidity!

Industrial distribution — like most wholesaler categories— is sales-intensive to a fault, and they’ve backed themselves into a mode of selling that is no longer successful. They are throwing talented sellers into the field to give away consultative advice to production line engineers who create specs for purchasing agents who shop the hell out of them. The wholesalers with the best consultative sellers are at a competitive disadvantage because the value they provide necessitates a higher cost structure in the form of bigger salaries and commissions. The wholesaler who wins the order is the one who doesn’t bother with sales talent and therefore enjoys a lower cost structure.

The better industrial distributors should be charging for consultation and giving away product for cost plus whatever physical processing and shipping fees are incurred. This pricing scheme would work much better. Catalog houses make 10% or so pre-tax and don’t have nearly so high a sales expense, but they do have relatively complex marketing departments and they sell loads of industrial supplies.

Q: But most wholesalers won’t be able to function like a catalog house or your modern, self-service gas station example. There are far more product complexities in most distribution fields than three grades of unleaded gas, plus milk and Twinkies at the counter.

BENFIELD: Yes, there will always be a need for technical and new-product sellers, as well as for relationship-management sellers. But the strong technical distributors will be forced into consultative fees for problem-solving. Most distribution sellers are allocated by geography, which has nothing to do with a specific customer’s specific needs. Nor does it do much to match a seller’s strengths to a customer’s service requirements. Organizing work loads by territory is done to keep travel costs down or to make the math for figuring compensation easier. Covisint, an e-commerce purchasing platform between automotive manufacturers, is being pushed because these corporations feel there is serious inefficiency in the industrial supply chain, and I totally agree.

Q: What then do you see as the new model?

BENFIELD: "Two things will happen, and both will transpire because of e-commerce. First of all, distributors will use technology to give their customers meaningful choices on how they buy. For instance, a distributor could say: "You can go to my web site and buy on line. Or you can buy on line and use an inside seller for product questions. Or you can buy the way you always have, with my sellers around ‘just in case.’"

The rubber will meet the road when distributors create meaningful price levels for each of these three transactions. The cost of an inside and outside sales force is somewhere between 8 percent to 11 percent of sales, or roughly 45 percent of all operating costs. The winning distributor will likely do three things: First, he’ll pass on 5 percent to 7 percent to the customer who orders on line. Second, he’ll charge a time-based fee for the inside-sales consultation. Third, he’ll let the outside seller be paid a consulting charge, or the customer can pay for the just-in-case transaction like before.

The other major impact of e-commerce on distribution will be an outgrowth of this move to charge the customer according to how he buys. The winning distributor will differentiate his organization by offering services for fees, while branding the high value-added services by promoting them the way he does his major product lines today. Instead of positioning himself as simply a Kohler, a Trane or a Square D distributor, he’ll advertise, for example, his same-day delivery or inventory-management services. He’ll create separate identities, logos, advertising and promotional strategies for these special services, just like he pastes a Kohler or a Square D logo on his co-op advertising today.

In the end, I think distribution will move from a sales-driven, just-in-case structure, to a lean, buy-it-how-you-want-it culture. As far as the sellers go, inside sales will be lean, but still powerful and very much in need. There is just too much to do for the customer that can’t be captured or delivered on a computer screen.

Outside sales is a real problem, though. There’s going to be a substantial downsizing of their duties. Imagine if you had a competitor who basically said to the customer: "Buy it on line and save a nickel out of each dollar." This operator would build volume quickly, and any competition who tried to cut price and duke it out just couldn’t compete.

Q: Do you see distributors making the right choices with e-commerce over the next five years?

BENFIELD: The decade ahead is going to be very interesting, and the overall distribution business will look very different at the end of it. Today’s independent, family-owned and -operated distributor seemingly has very limited options on how to deploy the equity he has built up in his firm. Marketing could help with profitability, strategic direction, and promoting the real value he delivers to his customers everyday. Unfortunately, most wholesalers are burdened with loads of price-cutting sellers, and maybe one or two marketing people who really don’t have much power to influence the situation.

Still, I fully believe that distributors will begin to change their sell-like-hell cultures, using technology to do it. The additional profits they generate through a more strategic approach to pricing will go a long way toward paying for the new technology. They can start by trying out different pricing and buy-how-you-want-to combinations, to determine the model that fits their customer bases the best.

The guys that do this first and do it well will win big. Those who insist upon retaining their just-in-case sellers are going to have a tough time competing.

Scott Benfield can be reached c/o Benfield Consulting, 423 Warwick Drive, Naperville, IL 60565; (630) 428-9311; FAX (630) 428-9311; e-mail: bnfldgp@aol.com

For more information on his latest book, Capturing Value: A Guide to Strategic Pricing for Wholesalers, contact Lisa Woodward, c/o Loran Nordgren & Company, 4 West Nebraska Street, Frankfort, IL 60423; (815) 469-9100, ext. 14; FAX (815) 469-2555; e-mail: Lisa@LNCmail.com.

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