Succeeding with fee-based services

by Adam J. Fein

Over the next five years, both fee-based services and fee-for-service pricing will grow sharply in the wholesale distribution industry, but significant barriers to success remain. This conclusion comes from the new “Facing the Forces of Change: The Road to Opportunity” report (available at www.nawpubs.org). 

To help you better understand the future profit model and its impact, we use the following terms in this article:
• Fee-for-service pricing — Customers pay directly for services rather than having services included (unseen) in product prices.
• Fee-based services — Services wholesaler-distributors offer to customers for a separate fee.

The standard wholesale distribution business model sells products and adds value. Historically, distributors have been paid for the value they add in the form of gross profit dollars — the margin added to the cost of the product to cover operating expenses and profit. Support and other services are included in product price, making them seemingly free from the customer’s perspective.

Exhibit A

This is where the fee-for-service pricing concept enters the picture. Creative distributors can offer customers new services and charge for them rather than building them into product margins. Wholesale distribution executives were skeptical about fee-for-service pricing in our 2001 “Facing the Forces of Change” study. However, just three years later, this skepticism has faded. A clear majority of wholesale distribution executives at companies of all sizes expect to charge fees for at least some services by 2008 (see Exhibit A).

Despite this optimism, distributors will only succeed by offering new services that directly improve the customer’s profitability and operations. Distributors can leverage existing relationships, build on traditional competencies, offer new value and get compensated appropriately for the value provided. This article provides four strategic guidelines to help distribution executives achieve success with fee-based services.

Fee-based services must deliver value to customers
What appears to be a unique or valuable service can become commonplace in a few years as competitors join in. A fee-for-service pricing approach will succeed only if distributors offer services that directly improve the customer’s profitability and operations.

A distributor must also be able to offer the service credibly. Kitting and packaging, cited by 87 percent of distributors in our study, is an example applicable to multiple customer segments. Distributors can provide products “as is” from manufacturers for customers to resell or consume. They can also group and combine products to meet specific customer’s needs. If, by doing so, costs are taken out of the customer’s business, a new value will have been offered and delivered. Success here is not measured by delivery times or fill rates, but rather by customer productivity gains, labor savings, ergonomic improvements, or a faster time-to-market.

Prepare for more accountability
Customers will consider services that can lower costs and drive profits. In return, they will demand guarantees. Fee-based services will change the relationship between customer and distributor. Distributors will be forced to deliver specific, measurable results as well as maintain excellence in their core activities.

Today, distributors can offer high levels of product availability and delivery, but often the only money-back guarantee put forward is the manufacturer’s product warranty. Everything else is marketing salesmanship: “Buy from me because I’m more consistent and reliable than my cross-town rival!” If the customer is not satisfied, the only recourse is to switch distributors.

For instance, a distributor can offer to analyze a customer’s operations, guaranteeing cost savings and be paid from the savings generated. Customers will be open to this service because they pay only if the consulting delivers results.

New fees for old services will not work
Many distributors still see fees as a way to charge for something that used to be given away for free. Obviously, customers can be expected to resist paying for something that once was free, even if they acknowledge the economic logic behind the concept. Distributors have been complaining about falling margins for years. Some customers will see fee-for-service as no more than self-serving behavior by distributors.

You are likely to face the following consequences if you do no more than merely add fees to existing services:
• Customers will cherry-pick the help they need and pay only for the support they receive.
• Customers will seek out distributors that provide value-added service “for free.” The wholesale distribution executives in our study believe competition from other distributors will be the biggest barrier to widespread use of fee-for-service pricing.
• Customers will successfully demand that the cost of the service be deleted from the product price. In the end, this gives customers what they seek: lower prices without compromise. Sensing their buying power and being rewarded for their efforts, customers will turn the screws again and again, seeking more concessions and squeezing distributors even tighter.

For example, our “Facing the Forces of Change: The Road to Opportunity” study found that industrial distributors that cannot offer some sort of on-site inventory management will be at a distinct disadvantage, since 95 percent of industrial distributors in our study plan to provide this service to customers by 2008.

Therefore, it is somewhat surprising to find that 73 percent of industrial distributors plan to charge a fee for this service by 2008. The prevalence of this service and the lower-than-expected switching costs has allowed industrial customers to essentially get this service free from their distributors. Many distributors are unable to charge fees or generate sufficient product margins to cover the associated costs.

Just like products, services have a lifespan. They can be imitated by competitors. Fee-based services will require reinvention over time to appear relevant and new. Clearly, it will be difficult to recover fees for simply doing the same thing everyone else is doing.

Let customers help you
Distributors are in an excellent position to capture the services opportunity because they are already on the front lines serving customers every day. You understand the customer’s operations and have resources and skills that can be used to drive out costs.

Value-added distribution services must be customer-driven. You must talk to customers, understand their business challenges and goals and determine how your competencies and knowledge can drive specific, measurable gains in their business. Figure out how to make yourself indispensable by taking over some of your customer’s more critical tasks.

Our approach for helping wholesale distribution executives identify new value-added and fee-based services is a three-step process:

1) Create a complete, end-to-end list of activities spanning the complete range of customer expectations across pre-sale, transaction and post-sale phases.
• Review existing chargeable events (technician time, custom packaging, expedited delivery, etc.).
• Brainstorm for new services based on customer needs.

2) Prune the list to five or 10 items representing a mix of valuable services and innovative options.
• Ask customers to rank each activity in importance to the success of their business.
• Explore your customers’ current service expectations. Do they expect all distributors to provide this service for free? Or, would your company be unique in doing so?
• Ask your customers to rank your company’s perceived strengths relative to other distributors or other service firms that could provide the service.

Bundle value-added activities into a coordinated offering or program.

3) Organize a working session with cross-functional participants from your business and one or more of your leading customers. Ask the group to validate the service offering by explaining how the service solves the customer’s problems. Identify barriers and workable solutions.

4) Identify specific metrics to track the business. Gross Margin Return on Inventory is a valid financial metric, but it is not linked in any way to customer needs or satisfaction. You must use metrics appropriate for a service business, such as personnel utilization rates and the profitability of alternative service lines.

As products increasingly become commodities, customer service will become the true differentiator. Distributors have an opportunity to become suppliers of customized and differentiated relationships that provide products with related services instead of merely reliably providing goods. Thinking about services can be a launching pad for generating new strategies in your company.

This article appeared in the March 2004 issue of Progressive Distributor. Copyright 2004.

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