It may be time for distributors to set aside their old business model in favor of a new approach. Sound provocative? The following three new models for distribution are worthy of consideration and debate.

by Scott Benfield

For some years now, industrial distributors have been hot on the trail of value added. The concept of the value-added chain is simple enough. When you look at the vertical markets of raw material to end-user, value is added all along the chain by manufacturers, assemblers, distributors and sometimes specifiers or influencers.

Putting this into concrete terms for industrial distributors, the average cutting tool gets iron ore from a mining operation, is smelted into steel at the mill, forged and machined at the manufacturer and stocked by the local distributor. From raw material to finished product on the distributor’s shelf, each discrete operation adds value.

Value is a complex subject. Its future lies in strategy, marketing and operations (not only selling), and sales training on demonstrating value is only a small part of the puzzle.

Many distributors trust that somewhere, in their current business model, they can break apart their processes, put a pencil to them, carry their notes to the Big Bad Customer Purchasing Agent (BBCPA) and convince him to not shop price on their newfound value. Distributors are betting that their channel reduction efforts, product substitution and application expertise demonstrate enough value to hold the BBCPA at bay. All they have to do is quantify the value. While this may be true, I am increasingly convinced that this approach is anachronistic and is in large part why distributors have lost income while reducing operating expenses.

First, value has to be created, made tangible and marketed (not simply sold). There is a process for this that, once learned, lets the distributor replicate value. Second, the concept of adding value means we must demonstrate, or literally do something more than we are now. In some instances, there is room for distributors to do less, do it more consistently and price accordingly. In other words, less value may be more for certain customers. Finally, no matter how much value we add, in whatever ways we add it, if we don’t capture it in pricing, we donate it in a razor-thin margin business.

Service marketing and the Packard
Distributors are primarily service organizations. Their services are unique, authentic and their raison d’etre. Beyond this, services have to be measured, quantified, mapped and executed with consistency. This process is called service marketing.

Some distributors have engendered pieces of service marketing through ISO certification. But ISO standards are only a beginning in developing service value. Distributors with managed inventory arrangements have demonstrated good process documentation and channel process reduction. The problem with process documentation, mapping and streamlining is that it results in incremental improvements on an old model of business.

In the early stages of any industry, sellers hold the keys to the kingdom. Our industry, however, is 75-plus years old, and the old model of distribution may not fit today’s and tomorrow’s customer like we want it to.

For example, distribution has added incremental improvements such as warehouse automation, economic quantity theory of inventory, sales automation, ISO and modern financial principles of return-on-capital on a 75-year-old business model. These improvements have allowed distributors to run the business with greater success. But, no matter how much you soup up the Packard, it still guzzles gas, rides bumpy, leaks and is about as aerodynamic as a refrigerator. At its core, the original distribution model is still a Packard with loads of sellers, branch managers, purchasing gurus, fleets and salesmen turned CEO. In short, the real problem may be the model of business. To transform it to tomorrow’s standard, we may have to shelve the Packard instead of incrementalizing it with improvements that give diminished returns.

Salespeople sell and promise services to any number of different customers. This is fine in the first stages of a business, but as the business matures, selling all over the place creates an environment where too many things have to be done for too many people. Sellers calling shots on services, pricing and operations may not be the best way to go to market. Serious strategy planning should involve all elements of the organization.

Value comes into play when one realizes that only so much new value can be added and managed with an old model of business. Value involves trade-offs, a strategy and a model that says, “We will structure our firm to serve X, Y and Z segments and leave the other segments to someone else.” You seldom hear this from sellers.

Capturing value in pricing also becomes problematic because the old model doesn’t allow customers to choose which services they want and which services they will pay for. In essence, the old model of business lets sellers create new services, roll them into a commodity product, negate and commoditize their unique value, and increase the cost of business without capturing the new service value in pricing. This, in part, explains the profit decline of industrial wholesalers in the previous decade. One new model for wholesaling is to separate new and marketable services, give them a brand identity and price them separately from the commodity product.

Where and how exactly the new models will manifest themselves is anyone’s guess. The new models of wholesaling will be driven by one overriding factor. Since the customer knows much of the product, it will be important for wholesalers to deliver value on how the customer wants to buy and not necessarily what they buy.

Creating and capturing value with new models
Three basic models of wholesaling are plausible in the near future. Instead of a one-size-fits-all wholesaler, there likely will be a handful of models that offer customers the choices of today’s wholesaler but with a better price-to-value ratio.

The first model is what I call the transactive model. In essence, the transactive model assumes an economic buyer who is primarily interested in cost. The economic buyer knows what he or she wants and is willing to search for the transactive distributor that will provide it at a low cost.

Technology will be important for the transactive buyer. A full-blown, robust e-commerce capability with usable parametric search logic will be key. Pictorial content will be just as important as engineering, application or schematic content, and this will aid the customer in internalizing the ordering process. And, of course, the customer will be induced to buy because of a low price.

Where will this low price come from? For the typical distributor, certain costs are immediately open for reduction. First, the inside and outside sales costs of 7 percent to 10 percent of sales will reduce drastically. If the operating costs of the average industrial wholesaler are 19 percent of sales, the “just-in-case” seller represents 35 percent to 50 percent of the operating cost. In the transactive model, outside sellers are largely gone, and customer service representatives with product knowledge will replace inside sellers.

How much cost can distributors remove by eliminating just-in-case sellers? That remains to be seen. However, if the cost of sales is 9 percent, it is reasonably easy to get a robust e-commerce model, advertise it and add customer service representatives for a lower long-term cost, passing the savings on to the customer.

The sales function is not the only function to be reduced in the transactive model. Inventory management will streamline costs by limiting manufacturers, setting up e-commerce purchasing and, in general, cutting down on the number of buyers. Transactive distributors will closely examine trade-offs on inventory width, breadth and depth. And, finally, they will trim services and offer a small range of consistent, low-cost options.

The transactive model of wholesaling is the most radical of the new methods. It requires a sustainable low price from streamlined operations, little flexibility and using cost-effective sales channels. It is doubtful the new model will come from an existing base of business. It is too disruptive for the traditional wholesaler to implement. However, wholesalers can create the new model by moving to a separate building, changing sales methods and hiring managers who can create a low-cost process while leveraging certain aspects of the old platform.

The consultative, or fee-based, model
The second distribution model is called the consultative, or fee-based, model. In this model, the wholesaler may or may not have e-commerce capability. Inside sellers will still be around, but outside sales will drastically change. Outside sellers will act as consultants on product, technical and application issues, and will be paid a fee for their service. The distributor will no longer give the service away to be shopped by the BBCPA.

To sell service options, the consultative wholesaler will research, develop, pilot and brand promising services. The services will run the gamut of imagination. But to be effective, consultative distributors will require marketers to manage the New Service Development process (NSD).

Other industries have developed service products for fees specific to segments. Banks, insurance companies and the medical community are further along this path than wholesalers. Wholesaling can develop these capabilities, however, and it’s up to top management to start the change.

You could add new services to the Packard, but this is a redundant, clumsy way to do business. Why? Developing service recognizes service value. It is championed by marketing, with operations fulfillment. Hordes of geographic sellers only cloud this issue and create friction.

Changing the mode of selling to the best consultants allocated according to their functional strength gives New Service Development marketers keen insight into the needs of customer problems. For instance, having an application specialist who charges for sales consulting and works with marketing to develop new, billable services based on specialized insight is the way to get marketing and sales to work for profitable customer solutions.

The consultative model is not as radical as the transactive model since it uses talented inside and outside sellers from the Packard. It is, nonetheless, a new model of business that will require substantive change.

The enterprise model
The last model, and most akin to today’s full-service distributor, is the enterprise firm. The enterprise distribution model is developed around full service of a handful of customers. Looking at wholesaling today, most managers realize their bread is buttered by the Pareto (80/20) customer base. The difference between the enterprise model and today’s wholesaler is recognition and structure of a value chain that services the needs of the largest customers.

The enterprise wholesaler pays less attention to new branches or new sellers and pays more attention to growing with the large customers by serving them more completely. Technology plays a major role in the enterprise wholesaler. The ability to communicate and link operating systems is crucial. In the enterprise model, the seller is really an ambassador whose job is to make sure wholesaler operations talks to customer operations, wholesaler accounting talks to customer accounting, and wholesaler marketing talks to customer operations, marketing and sales.

Selling in the enterprise model recognizes the need for top-flight inside and outside sellers. The outside sales function is most likely not allocated by geography but by customer industry or seller comfort zones. The key to success for the model is for the wholesaler to develop growth by serving the whole of the customer enterprise with whatever infrastructure change customers value.

Problems of culture and innovation vs. emulation
The average wholesaler is privately owned and in the second or third generation. Those that inherited and drive the business came from the business and learned the culture at an early age. The problem with transferring the business through the generations is that it perpetuates the old model.

Most second- and third-generation managers are astute businessmen, but they also emulate best practices rather than innovate new models of business. The overriding hurdle for new ways of business in a generational environment is to get new blood into the business to change the model. The strong culture of the family wholesale business probably won’t give enough latitude for an outsider to come in and develop a new model. The existing family-owned wholesaler may be better off funding a separate business model than trying to change the Packard into its modern day counterpart.

An example of perpetuating an aging business model while providing incremental improvement is found in the Japanese economy. Once the fear of the western world, the economic juggernaut of Japanese industry has been stagnant for the better part of a decade. The consensus among most is that the Japanese were the world’s best at improving old-line business with incremental change. Their culture revered the old model of business and provided incremental change in the 1950s and ’60s to dominate in the ’70s and ’80s.

But perpetuating the old model with respect for elders is part of their downfall. The Japanese aren’t good at creating new models of business. In essence, they emulate and improve but don’t really innovate.

In the end, we must realize that value can be created from new ways of doing business, offering the customer choices on how they buy. It has to be captured with good pricing policy. Incremental training of the seller to demonstrate value is only a small step in the right direction. The biggest value gains will come with new models of business utilizing creative strategy.

This article originally appeared in the ISMA/I.D.A. 2001 issue of Progressive Distributor. Copyright 2001.

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