Flip the Switch to Improve Profitability
It’s 2020, the start of a new decade. Marketplace pressures continue to evolve and change the competitive landscape, ranging from commoditization to eCommerce to the changing workforce. These factors are beginning to negatively impact the bottom line for many distributors. Distribution is traditionally not a high-margin business to begin with, so these new realities can be concerning. What is your company’s profitability outlook for the years to come?
Rest assured, you can maintain and grow profitability even in a slow-growth market. SPARXiQ is committed to helping clients unlock profit potential regardless of market conditions. To showcase one example opportunity for doing so, we’d like to share an innovative solution that solves a long-time profit problem for many of our customers.
A Common, Complex Problem
Having worked with hundreds of distributors’ transaction data in recent years, it is always interesting to me when we find some of the same challenges in so many companies’ datasets. Very different companies serving different markets in different industries somehow tend to arrive at some of the same problems impacting their bottom line.
A study of hundreds of distributors’ invoice data reveals that the average distributor actually loses money on 40 percent of invoice line items when the actual costs to serve are taken into account. Essentially, the industry-average 4 percent net profit is the outcome of a struggle among invoice line items that make money, break-even (more or less), or lose money. The higher the percentage of orders that lose money, the lower the operating profit.
Let’s say a distributor sells 5,000 products (SKUs) to 1,000 customers. These items naturally have radically different costs to serve: average order quantities, inventory turns, handling costs, customer service needs, etc. Unfortunately, typical distributors’ pricing matrices don’t reflect these highly-variable costs to serve – particularly at the SKU level. It’s a problem created by the complexity of the situation.
As you might imagine, profitability of a given line item on a given order will depend heavily on its unique cost-to-serve factors. As such, invoice line items with high costs to serve wind up being unprofitable.
A Surprising Culprit
When you factor in all of the costs to serve, which line items typically drag down the profitability of an order? You might be surprised to learn that the long tail of ancillary, add-on products are those that are most likely to drain profitability by 50 percent or more. This is ironic, given that these products are often seen as convenience products which should build margin onto the primary SKUs on an order.
The reality is that the cost-to-serve variability of these items is rarely accounted for and standard gross margins applied to these items result in compromised profitability. Identifying, and remedying, these profit drains on products with unique cost-to-serve challenges is a path to a much better bottom line. In fact, companies that successfully address this problem can predictably increase net income by 1 to 2 margin points ($100,000-$200,000 per $10M in annual revenue).
The Behavioral Component
Downstream, distributor sales reps generally lack visibility into each product’s true cost to serve and how that compares to the margins at which they are selling. In their quest to fully serve their customers, sales reps say yes to selling practically anything a customer wants. That’s not necessarily a bad thing; that’s their job. However, it’s the company’s job to ensure that the right guidance and boundaries are provided to inform those sales decisions, so that the right products are sold at the right margins.
To compound the problem, when these same sales reps have significant pricing latitude and/or a cost-plus approach to pricing, the table is set for a high number of money-losing orders. When sellers apply a favorite margin percentage (usually ending in 0s and 5s, as we’ve found) on the vendor cost of a product, it may prove adequate for the high-volume, high-efficiency products that receive most of the profitability attention.
However, with the long tail of ancillary products, that approach breaks down, driving up the percentage of money-losing orders and driving down net profitability. A similar phenomenon happens for reps doing list-down pricing, as they apply blanket, peanut-butter discounts across products with radically different costs-to-serve.
Distributors have been trying for ages to break these sales force behaviors, but old habits die hard. Any proposed solution to remedy profitability on long-tail products needs to meet the sales force where they are, not where companies wish they’d be.
A New Solution to an Age-Old Problem
A solution to this complex problem for distributors must be one that:
- Can surgically, quickly and accurately identify the problematic SKUs
- Can make the necessary adjustments directly into daily workflow (in the ERP)
- Doesn’t ask salespeople to change behaviors
A potential solution would struggle to succeed in a case where any of these three requirements weren’t met. Many distributors have tried to solve this problem internally, but not always found it easy to accomplish the three critical points above. And, in many cases, they’ve dedicated a lot of staff time and manual processes to the effort with minimal returns. SPARXiQ is proud to bring a simple solution to help distributors solve this complex problem.
Switch™ by SPARXiQ is available through native integrations into leading distribution ERP systems. Switch adjusts the stated cost or list-price basis of these long-tail products that commonly drain profitability. That means salespeople are calculating sale prices based on corrected, more accurate costs and the benefits go straight to your bottom line.
Click here to learn more about Switch and contact SPARXiQ to see how you can unlock significant profit potential waiting for you in your ERP system.