Lean distribution and the need for sales cost reduction

by Scott Benfield, Benfield Consulting

In a recent pricing audit, we came across an increasingly common issue where the perceived need for pricing is a symptom of a deeper problem of cost overruns in the service platform. Our client, a large national distributor, contacted us after reading our book Pricing Management: Capturing Value for Distributors (available from NAW at http://www.naw.org/pricingmanage or by calling Vicky Walsh: (202) 872-0885). They were convinced their firm had poor pricing processes.

During the audit, we discovered a segment of business that had the following fundamentals:
• negative activity profits;
• slowing and, in some areas, receding sales;
• small transaction sizes ;
• significant number of stock SKUs to serve the customer; and
• significant credit risk from the account base.

In essence, the profile of the customer segment suggested it would be costly to serve.

The slowing/receding sales were worrisome and after consulting with field sales and financial analysts for the industry, we found the client had a higher gross margin than the competition and significantly higher operating expenses as a percent of sales.

We also benchmarked key competitors and found the following dynamics:
• large branches with a broad inventory vs. our client’s numerous small branches;
• outside sales used only for the largest of accounts vs. our client’s numerous sellers assigned to geographies and numerous small accounts;
• liberal use of telesales where our client had none;
• liberal use of e-commerce where our client had none;
• significant purchases of knock-off brands from China;
• encouragement of credit card sales vs. extending credit.

From the research, we advised our client against seeking aggressive pricing gain in this segment. The problem was their model of business was too costly to compete. Pricing would have exacerbated the situation and put them at a greater competitive disadvantage. Their need was to rethink their model of business and match it better to the cost dynamics of the segment. Furthermore, a significant cost that needed to be streamlined was full outside and inside sales services. This was troublesome to the current CEO as he was a believer in the power of sales to demonstrate value and grow the firm.

Sales restructuring and Lean
In the previous example, a significant part of the go-forward strategic plan for our client included reducing solicitation costs. Inside and outside sales were 35 percent of operating expenses and this is not unusual for traditional distribution. An e-commerce only model would cost less than 5 percent of operating expenses and telesales only would cost an estimated 10 percent of operating expenses.

Restructuring the sales force to garner these efficiencies is not easy, however, as the firm must maintain quality service while amending the solicitation model(s) to the long-term growth strategy. In our 2006 release, Restructuring the Distribution Sales Effort (available from NAW at www.naw.org/restructuring/ or by calling Vicky Walsh: (202) 872-0885), we offer a full rendering of how to right size and/or change the solicitation effort for greater efficiencies and offer greater value.

The book begins with how to size a geographic sales force for maximum productivity and discusses that, in general, geographic deployed sales forces are slowly dying. The reader will become familiar with techniques such as FTE analyses, activity thresholds and migration analyses. The firm must move to Hybrid Marketing where there are numerous options of sales models including consultative, enterprise, segmented and transactional selling functions. The book then discusses five alternative models of inside sales including generalists, technical specialists, personal account managers, customer service representatives and telesales. And, finally, the book discusses alternative compensation models that support different sales strategies. In total, we find it is entirely possible to reduce sales and solicitation costs by 30 percent to 40 percent and still give the customer meaningful service.

The need for sales restructuring and sales cost reduction in distribution is real. The vast majority of products sold are commodities that are increasingly less in need of full sales service. Many customers know what they want to buy and are less tolerant of the cost of full inside and outside sales. In two market research projects in 2000 and 2004, we found that upwards of 75 percent of industrial customers would prefer buying from a catalog/fax or e-commerce when given a cost reduction commensurate with the traditional cost of sales support. Add to this the efficiencies of fewer but larger branches and knock-off brands from China and the cost platform can be greatly reduced for long-term gain. Those companies that don’t see these cost reduction options may find themselves in the unenviable position of our client in the opening paragraph. At some point, if the competitive low-cost model develops momentum and scale, the battle for the market is won before the high-cost distributor decides to react.

The false security of commodity increases
The impetus for our book on restructuring the sales effort came from market based and financial research of industrial distribution channels. The time period for this research was the decade from 1994 to 2004. Distribution during this period was hit with slowing domestic demand from both economic and market forces, commodity price stabilization and, in some sectors, price deflation. The profits for distributors during this period plummeted and it was predictable that the cost platform would have to change to allow distributors the chance to earn financial returns that paralleled the equity markets.

Starting in late 2004 and continuing through the current period, we have had significant increases in basic raw materials costs, including petroleum, plastics and metals. In most instances, these increases have been three to four times their prices of a few short years ago. In this environment, distributor profits have rebounded as the extra margin dollars generated by commodity inflation have leveraged the operating expense base. Some, perhaps most, distributors see the current commodity appreciation as sustainable and the need to streamline costs, including sales, to be yesterday’s issue.

We, however, believe that the current environment is a false security. First, while worldwide demand of basic commodities is up, it is nowhere near the 300 percent to 400 percent price appreciation of recent years. Much of the increase in commodities is driven by speculators who are dumping money from the declining real estate sector into appreciating commodity markets.

As supply and demand reach equilibrium, the commodity prices will significantly decrease, wage inflation will mount, borrowing rates will rise and consumer spending will flatten or decline. In short, the quick cost increase in natural resource commodities will decline and distributor margin dollars will decline accordingly. We see the current commodity appreciation as a false security and note that the most recent period where this occurred, the late 1970s, preceded the worst post-war recession of the U.S. economy.

We expect a market decline from inflation and higher interest rates to begin in earnest in 2007 and this will be followed by a gradual fall in raw material prices due to a decrease in demand and movement of speculative capital to more high-yielding sectors. In short, distributors should prepare now for reducing sales costs and streamlining their model of business. The rise in commodity prices and ensuing rise in distributor income, won’t last and the competitive advantage will fall to the distributors who streamline their service costs including sales and solicitation. Careful reading and application of the principles and case studies found in Restructuring the Distribution Sales Effort can help.

Scott Benfield is a consultant for industrial channels in the sales and marketing functions. He is the author of four books, all of which can be found at NAW Publications at www.nawpubs.org. Scott can be reached at (630)-428-9311 or through his Web site at www.benfieldconsulting.com.

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