The world of an electrical distributor with less than $25 million in annual sales is changing fast. With net margins down to their lowest in years and new competition from larger distributors and alternate channels, distributors of this size are looking at their businesses more critically than ever.
Despite these challenges, many of the smaller electrical distributors who responded to a recent survey conducted by Allen Ray Associates have a positive outlook toward growth and expansion. Virtually every survey respondent said their knowledge of the local market gives them an advantage over chain distributors, home improvement warehouses and other sources of supply for electrical products. Three-quarters of the survey respondents saw good growth for their companies over the next five years. However, to achieve this growth, they must overcome some big challenges:
Effectively managing profits and pricing
Realizing the true cost of excess inventory
Maintaining profits on slow-moving inventory
EFFECTIVE PROFIT & PRICING MANAGEMENT
Distributors often claim market conditions drive their pricing, and thus their profit margins. This has been true in the past, and some distributors will do anything to get an order. But 82 percent of the respondents said pricing and profit effectiveness are now two of the most important aspects of their businesses.
That being said, many distributors don't effectively control their pricing. Many respondents haven't reviewed their customer's pricing in years. Too many distributors let sales set the pricing levels. That's changing. Whether a distributor uses a consultant to survey price levels and pricing rules — or is large enough to form a pricing committee — many companies are becoming aware that their costs and pricing don't stay constant. Many respondents realize the failure to address costs and customer pricing destroys business and lowers margins. Some distributors attributed a lack of pricing effectiveness as a failure on their part to give their salespeople direction and motivation to sell value and not just take orders. Many confessed they have been in a survival mode — concerned with getting the business now and worrying about profit later on.
But the survey indicates this attitude is changing. Some respondents are assigning bottom-line responsibility to employees other than sales personnel — a big change in business philosophy for many distributors. It's time for electrical distributors to identify real costs, adjust prices and reclaim margins.
THE REAL COST OF EXCESS INVENTORY
An important element of managing price and profits relates to excess warehouse inventory. Some respondents are carrying as much as 28 percent excess inventory and are suffering the consequences: poor cash flow, high carrying costs, product obsolescence and inadequate working capital.
Twenty-four percent of the respondents said they maintain excess inventory because they believe they will eventually sell it. While some distributors had reduced their overhead and increased their collections activity, many had allowed nonplanned “inventory creep” to cause cash-flow problems. Relatively few distributors believe they will have a customer “someday” that will want that slow- moving product. When respondents were questioned about the cost of carrying of those slow-moving items, 36 percent considered just the interest rate at the bank to be their cost of carry, and not insurance, rent, phone and other overhead costs.
On the bright side, many distributors have liquidated excess inventory and turned their purchasing function into a profit center that controls inventory creep by assigning responsibility for inventory performance to an employee or committee.
When a distributor carries 28 percent excess inventory, it's no wonder there are cash-flow problems. If, in addition to excess inventory, a distributor has collection problems, it further endangers cash flow and ultimately the entire business. Electrical distributors must realize liquidating excess inventory frees up much-needed operating capital and will lowers cost of carry.
MAINTAINING PROFITS ON SLOW-MOVING INVENTORY
Many distributors are having a hard time maintaining margins on slow-moving “C” and “D” items. It's a tricky balancing act for electrical distributors. They want to carry the products customers need, but they are not making the necessary profits on this slower-moving inventory to cover carrying costs. In fact, most distributors don't realize they are literally giving away profit and overheard cost without recouping it. This is a slow and painful way to go out of business.
Standard pricing authorizations (SPAs) and ship-and-debit pricing continue to be two of the biggest headaches for independent electrical distributors. Neil Gillespie, president, Channel Marketing Group, Pittsburgh, defines an SPA as an authorization by a manufacturer to a distributor to sell to a group of customers or a specific customer at a lower price than normal distributor cost. Ship-and-debits are another term for the rebates distributors try to get from manufacturers after they buy items for stock at normal distributor cost, and then sell some of this inventory to accounts with SPAs. They claim rebates from the manufacturer for the items invoiced to the customer, says Gillespie in an article posted last year at www.naedtechnologyinformer.com.
Many respondents expressed feelings of bitterness and distrust toward manufacturers regarding SPAs and ship-and-debit pricing, and said true partnerships with manufacturers were tough to come by because of them.
A big problem with SPAs is electrical distributors are either chasing paper on SPAs when they need to dispute the vendor, or their business software systems cannot handle the complexities of the transactions. Either way, distributors pay a heavy labor cost to just collect their profit on some items covered by an SPA.
When survey respondents were asked whether they collect all of their SPAs or rebates, 85 percent say they don't get all of the rebates for which they qualify, either because distributor personnel overlooks them, software doesn't recognize them, or distributors fail to classify the customer correctly. These problems can have serious consequences, and because of this frustration level with vendors, some respondents are switching product lines when possible. But oftentimes, distributors are left with having to play the manufacturer's game when it comes to SPAs or rebates.
GROWING VS. SHRINKING MARKETPLACES
Respondents had drastically different opinions about the health of their marketplaces. With 22 percent of the respondents, pessimism (or maybe realism) has set in. They are expecting their market and their business to shrink over the next five years. They attribute this shrinkage to the growth of national and regional chains in their markets, the growth of niche distributors that focus on lamps, tools and other product areas, and the move by some manufacturers to sell direct. The number of distributors that see this shrinkage has risen from 15 percent last year to 18 percent this year. There weren't any specific geographical areas where this trend was most common. But there appears to be a correlation between the group of distributors with cash-flow problems, inventory concerns and high rates of excess inventory and the respondents who expect their market shrinkage to be somewhere between 5 percent to 25 percent.
Seventy-six percent of distributor respondents have a “pro-growth” outlook and see their market growing for the next five years. As a group, these distributors appear to have less problems with cash flow and collections but still report genuine problems with pricing, margins and excess inventory. Respondents with branch locations had real concerns about their branch managers understanding a cash-flow analysis and being able to react to it.
In general, the pro-growth distributors said excess inventory was a constant problem that could result from their purchasing habits. These distributors believe growth will come from several areas:
Increasing geographical coverage by adding new branches
Achieving greater market penetration with existing customers
Changing to a more profitable market focus
Preplanning to add specific new customers
Increasing geographical coverage by adding new branches. As national and regional chains withdraw or consolidate in some markets, many distributors see excellent growth opportunities.
Achieving greater market penetration with existing customers. The key here is getting more profitable business, not more collection problems. This requires an electrical distributor to know a customer's business and plans for growth.
In some cases, it will mean connectivity through some sort of electronic technology. EDI has been around for many years, and contractor business software is emerging that allows for greater connectivity with selected distributors. TradeSync, a business software package offered by Clearbridge Inc., San Francisco, is an inexpensive delivery of acknowledgments and invoices to a customer's business or accounting package.
Change to a more profitable market focus. One respondent said, “If you can't make money with your current market focus, why should you continue focusing on what doesn't work? Change your market focus.”
Preplanning to add specific new customers. Many of the pro-growth distributors report that doing more homework on potential new customers before adding them as new accounts is emerging in importance.
BEST AREAS FOR RETURN ON INVESTMENT
All respondents were asked to rank in the order of importance how they perform in 12 key functional areas that would give them the highest returns for generating profit. Here are some lessons distributors can learn from the survey findings:
Analyze your prices, and profits will follow
The results reveal independent electrical distributors are looking at pricing and profit effectiveness with equal importance. If pricing is properly and aggressively managed, it can be one way to increase profit (and perhaps the fastest). If not managed, distributors are giving away profit without realizing it.
Three distributors reported that when steel and copper prices were rising earlier this year, they increased their incremental pricing on those products by increasing margins at the same time. Many respondents also are considering using outside audits as a tool to solidify pricing rules and clean up their customer/price files. With good pricing rules in place and profit accountability assigned, respondents believe they can increase profits if they control their overhead. At least one vendor now offers distributors the tools to do this. EpaCUBE Inc., Dallas, uses a hosted business software model to help distributors aggressively manage price and SPAs.
Increase your local market knowledge
Local market knowledge continues to be the most underrated area for increasing business. It's an advantage that gives many independent distributors the upper hand over national and regional chains. Several distributors said, “How you use this knowledge is really a reflection of any success you have in the marketplace.”
Treat purchasing as a profit center
With today's unstable market conditions, many distributors want to develop a profit strategy around their purchasing methods. This requires auditing, as well as training personnel to make smart purchasing decisions. In addition, some distributors are letting purchasing agents “own” the inventory regardless of what the sales department tells them.
The survey revealed some distributors do not believe they do a good enough job at purchasing or even understanding minimum/maximum inventory levels as they relate to customer-service levels or stock-out conditions.
Many respondents said when reps and vendors offer end-of-the-month or end-of-the-quarter sales “deals,” they now have their purchasing agents figure a return on investment (ROI) before accepting them. Unfortunately, many of these special deals force other portions of inventory out of balance and increase the level of slow-moving inventory. The owner of one three-house distributor realized he tied up good working capital by accepting a special deal that bit into his working capital.
The point is clear: The single greatest asset a distributor has is inventory. They should want to sell it and not just hold it.
Retrain salespeople to respect pricing levels and sell value
The overwhelming majority of survey respondents said when it comes to motivation of sales personnel, consistency and being able to perform at “crunch time” is very important. But many survey respondents said they feel inadequate in trying to perform activity-based management of sales performance or to train sales personnel to sell value.
A trend seems to exist among respondents toward taking away the final pricing levels from sales personnel and assigning them to an employee who has net-margin responsibility. This forces higher margins.
Build more profitable partnerships with customers
Many respondents want long-term supplier relations to improve marketing effectiveness in their individual markets. Twenty-four percent of distributors are considering switching vendors because of the manufacturers increased use of claim-backs (SPAs and ship-and-debits routines) and how this undercuts their marketing effectiveness.
As one distributor said, “The manufacturer is actually contributing to commoditizing their products by using rebates.” One of the most common comments in the survey is that by giving the distributor's customer a low price, the manufacturer is in effect cutting value out of the sale.
That's because end-user customers become dependent on the lower price. Respondents said they would much rather have good net cost from vendors that would allow them to sell the product. But the majority of the respondents do not see manufacturers changing their pricing practices. In Part Two of “The High Cost of Low Profits,” we will take a detailed look at these strategies and explore how several distributors are improving pricing and profit management.
Editor's note: Market challenges are forcing small electrical distributors ($25 million in annual sales or less) to squeeze more profit dollars from areas of their companies they had previously overlooked — such as dusty warehouse shelves holding slow-moving inventory.
That's one of the key findings of a survey of smaller distributors done by Allen Ray, president, Allen Ray Associates Ltd., Arlington, Texas. Ray, an electrical industry veteran who has spent much of his career helping electrical distributors improve the profitability of their businesses, says survey respondents were quite willing to speak out on their attempts to improve profitability. In this two-part article, he analyzes the results of this survey and offers tips to on how distributors can operate more profitably.
MEET ALLEN RAY
In his 30-plus years in the electrical wholesaling industry, Allen Ray, president, Allen Ray Associates Ltd., Arlington, Texas, has built an expertise in pricing theory, special pricing authorizations (SPAs) and ship-and-debit routines. In his many years with Trade Service Corp., Ray worked with distributors in developing national/global account pricing structures, smart cards and loyalty pricing. Ray is a graduate of the Texas A&M University College of Engineering/Industrial Distribution. You can contact him at (817) 652-1143, or via e-mail at [email protected]
To see how your company's pricing philosophy stacks up against other distributors in your industry, go to www.allenray.com and click on “Hot Topics.” Fill out the survey form and you will receive a blind comparison of similar size distributors in the electrical wholesaling industry.