Tougher economic times demand that electrical distributors take action to increase gross margin and reduce operating expenses.
Electrical distributors are developing a greater appreciation and sharpened focus on the true cost of doing business with customers. More and more electrical distributors are now accurately measuring customer profitability. That same profitability focus also needs to be applied to suppliers. With the five-step strategy detailed in this article, you can learn to better manage the “buy” side.
Step 1. Conduct an accurate vendor profitability analysis by product line.
Conducting an accurate vendor profitability analysis includes analyzing Gross Margin Return on Inventory (GMROI), Vendor Profitability Index (VPI) and Rebates.
The basic objective of Gross Margin Return on Inventory (GMROI) per vendor is to determine the return on inventory investment. This ratio measures how many stock gross margin dollars are produced from each dollar tied up in inventory.
It is critical to track GMROI on a product line basis. This allows you to make better decisions on what vendors to form vendor strategic alliances, what products to keep and what products to delete.
To find the GMROI, take the Gross Margin $ on Warehouse Sales per Vendor and divide it by the Average Warehouse Inventory of That Product Line.
For example, suppose you have a vendor on whose products you earned $80,000 in Gross Margin on Warehouse Sales last year and held an average inventory of $60,000.
In this case, GMROI equals $80,000 divided by $60,000 or 133 percent. This GMROI reveals that for every dollar you invested in inventory of that particular product line last year, you earned $1.33 in gross margin on sales through the warehouse.
When conducting a GMROI analysis, you'll find GMROIs as high as 400 percent and as low as 40 percent. Shoot for a minimum of 125 percent. A good GMROI is between 130 and 160 percent. If your GMROI is lower than 125 percent, you're probably not making money on that product line.
A GMROI below 100 percent is a big warning light. If you have one, look at the line's gross margin percentage. If the gross margin percentage is acceptable for that specific product line, then your problem is carrying too much stock inventory.
Still, GMROI as the sole measure of vendor profitability has its limits. Gross margin can get eaten up fast by problems such as short shipments, wrong materials shipped, materials shipped damaged, defective products, missed promised delivery dates, partial shipments resulting in back orders, pricing errors, billing errors, etc.
Now, categorize all vendor errors that result in “rework.” Have your people involved in the purchasing process — sales, purchasing, warehouse and accounting — list the work they perform when a supplier makes vendor errors.
The key is to analyze one supplier error category at a time, do one per week, and do it thoroughly. Have your people record the amount of time spent the next five times the error occurs. Average the results to get your benchmark.
Next, establish a cost of the rework for each of the supplier errors. For example, if the vendor sends you the wrong materials and you have to ship them back, you can determine the hours of labor, wage rate and burden rate, including benefits, packaging materials, etc., included in the cost.
Soon you will capture the activity costs associated with each vendor error category and make estimates of vendor profitability using the Vendor Profitability Index (VPI), which is the Gross Margin minus the Cost of Vendor Errors.
Rebates are another significant measure of vendor profitability. When evaluating your vendors for rebates, the product group dictates the following rebate range as a percentage of purchases: wire, 2 to 4 percent; pipe, 1 to 2 percent; plastic conduit, 2 percent; fittings, 3 to 5 percent; lamps, 7 to 10 percent; switchgear, 1 to 2 percent on stock; recessed lighting, 2 to 3 percent; and fluorescent lighting, 1 percent.
The rebate range can be huge, but it comes down to how much you buy. Vendors offer more rebates as you expand the products you purchase with them along with the volume. Volume alone on the top-selling vendors' lines will not get them interested in you as a buyer. It is the breadth of their lines that they seek from you. For that, they are willing to offer greater financial rewards.
If you belong to a buying/marketing group like IMARK, Affiliated Distributors or Equity, the rebate also varies by product line and differs with what products you buy through the buying/marketing group. For the typical electrical distributor, it can be as low as 2 percent of purchases or as high as 5 percent of purchases.
If you are only buying wire from your buying/marketing group, your rebate is lower. If you focus on all lines through your buying/marketing group and buy lamps, it is higher. A good rule of thumb is to purchase a minimum of 65 percent of your purchases through your buying/marketing group to maximize your rebates.
Step 2. Create and implement a vendor report card.
In addition to vendor profitability analysis, you need an objective evaluation tool for key employees to rate your vendors on categories such as: order fill rates, on-time delivery, order accuracy, product quality, invoicing accuracy, etc. List every area that has a direct impact on your profitability in this analysis/report card. (See page 20.)
Again, select key personnel from all cross-functional areas — sales, purchasing, warehouse and accounting. Explain the reason for conducting vendor evaluations and elicit employee support. You can even involve employees in creating the vendor report card.
Step 3. Compare the results of the vendor profitability analysis with the vendor report cards.
When your vendor profitability analysis is complete, you will need to rank your vendors by GMROI, Vendor Profitability Index (VPI) and Rebate Dollars.
From the rank order of vendors by GMROI, consider the top 20 percent with whom you earn approximately 80 percent of your gross margin. These are the vendors with which you will likely want to enter into a vendor-partnering program.
The bottom 20 percent of the ranking will be represented by those with whom you have the lowest GMROI. Re-evaluate your relationship with these companies. It may be time to change vendors.
Don't bother with the middle 60 percent at this time. Work on the best and the worst first, then attend to the middle of the pack.
After determining the VPI for all your vendors, rank them, too. As with the GMROI, ascertain the top and bottom 20 percent. These vendors are the ones that make you the most money (top 20 percent) and probably cost you the most money (bottom 20 percent).
Once you've ranked vendor profitability using GMROI, VPI, and Rebate Dollars, compare these profitability results with the vendor report cards.
Using the five-point Vendor Report Card scale from the sample on page 20, set up a database and analyze the results by Vendor Satisfaction Index (VSI).
VSI is derived by adding the number of Excellent (rating = 5) and Very Good (rating = 4) scores and dividing by the total number of responses to obtain a VSI percentage.
In terms of analyzing the data, a VSI rating of 80 percent or higher indicates high vendor satisfaction by your employees in that area. Low customer satisfaction is represented by a VSI score of 60 percent or lower.
As you did with GMROIs, VPIs and Rebate Dollars, rank vendors by VSIs. Again, look at the top and bottom 20 percent and compare those rankings with your vendor profitability analysis.
Once you complete your vendor evaluation, you can begin the vendor consolidation process. Select the right strategic vendors to partner with and implement an aggressive marketing strategy that focuses on new customer acquisition as well as further penetrating of existing customers.
Step 4. Develop a vendor recognition proram and a vendor-partnering program.
Now that you know how to properly structure a supplier evaluation process, this forms the foundation for all actions concerning a vendor — from awarding more business to a vendor to eliminating the vendor as a supplier.
From your vendor profitability analysis and report-card rankings, select three “Manufacturers of the Year.” Because the ultimate goal of any supplier evaluation program is to improve supplier performance, it is important to share your evaluation process with your vendors. Send a letter announcing the program to each manufacturer. Communicate the four supplier evaluation tools and concurrent vendor performance goals — GMROI, VPI, Rebates, Vendor Report Card — and the time frame.
Continually promote the program throughout the year. Remind suppliers that their performance not only increases their chances of winning the award but will also have a direct impact on current and future purchases. Prepare and distribute quarterly vendor report cards and average the quarterly vendor report card results to compute your three winners.
One of the keys to a successful vendor recognition program is providing ongoing feedback to a supplier about its performance. When you receive an incomplete order, if products arrive damaged, or you experience any vendor error, notify the vendor immediately via phone and e-mail in addition to logging the vendor error.
In looking at your competitive landscape, analyze which competitors carry which competing lines to ensure you are effectively managing your “buy” side as well as providing any product differentiation in the marketplace. Are you just another “me-too” line card? If you are, then why will your vendor provide you with any pricing and support advantages?
Coming out of the recent economic slowdown, vendors will provide additional financial and operating support to those electrical distributors that generate sales volume increases.
Through your vendor performance results, given that you will execute a vendor reduction program with the bottom 20 percent vendor performers, you will likely be able to guarantee the top-20-percent vendor performers increased business.
How does this work? A select group of vendor-partner candidates are guaranteed a percentage increase in business over the previous year. For that increase and additional benefits, they provide the electrical distributor with additional funds, outside of any existing co-op and rebate agreements.
In the unlikely event that you do not attain the agreed upon percentage increase in business over the previous year, guarantee that your company will return the vendor funds.
Encourage your salespeople to support the vendor partners whenever possible to attain the guaranteed increase in business. Track on a monthly and year-to-date basis each vendor's purchases to goal so that you can better manage achieving the guarantee.
Successful vendor-partnering programs also provide vendor-partners with an annual planning session with all of their sales staff, semiannual strategic planning sessions, participation in customer-employee product champion training programs, sponsorship in frequent buyer programs, tickets to customer appreciation events, multiple product promotions during the year and preferred merchandising status at all locations.
Step 5. Implement vendor-consolidation strategies and vendor-partnering strategies. Meet with vendors to review vendor performance results.
Send congratulatory letters to the winners of “Manufacturers of the Year” highlighting their vendor profitability, vendor report card ratings and rankings. Send press releases to Electrical Wholesaling and TED and host a “Manufacturers of the Year” awards ceremony. Post the winners' names on your Web site and include them in other marketing materials. Your customers should know that you align yourself with best-in-class suppliers.
For suppliers that you want to target for your vendor-partnering program, send a letter outlining your strategy to select a few manufacturing partners to develop the best strategy to effectively market their products and your distributor services and invite them to attend a vendor-partnering meeting.
The best venue for presenting your vendor-partnering program offering is at NAED's annual meeting because all significant vendor management is present. Target vendor executives who can make the decision to commit funds to the program. At the meeting, present them with vendor-partner program materials that effectively sell the tangible benefits of combining strategic resources. Once committed, just like with the vendor recognition program, post your vendor-partners on your Web site and include their names in all customer and vendor marketing materials.
Some manufacturers that have participated in vendor-partner programs include: AFC Cable Systems, Alcan Cable, Erico, Essex, Ferraz Shawmut, Ideal Industries, Juno Lighting, Lightolier, Lithonia Lighting, Lutron Electronics, Murray Electrical Products, NuTone, O-Z/Gedney, Pass & Seymour/Legrand, Philips Lighting, Siemens Energy & Automation and Thomas & Betts.
Schedule individual meetings with remaining vendors to review their profitability and vendor report card ratings and rankings. Encourage good performing suppliers to improve their performance so that they can win a “Manufacturers of the Year” award next year.
From each poor performing vendor, secure a specific action plan with timelines to improve their supplier performance. If poor performing vendors are not enthusiastic about implementing performance improvement plans and making the grade, drop them.
Thomas J. O'Connor, of Farmington Consulting Group, is a strategy consultant for electrical distributors and a frequent contributor. He can be reached via phone at (860) 676-7876 or via e-mail at [email protected]. Or view Farmington's Web site at www.fcgltd.com.
PUTTING THE “BUY” SIDE TO THE TEST
- Conduct an accurate vendor profitability analysis by product line.
- Create and implement a vendor report card.
- Compare the results of the vendor profitability analysis with the vendor report cards.
- Develop a vendor recognition program and a vendor-partnering program.
- Meet with vendors to review vendor performance results; implement vendor-consolidation and vendor-partnering strategies.