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Cut MRO Costs With Your Distributor’s Help

Mon, 05/09/2005 - 7:05am
Distributors can help you cut MRO costs, says this expert, but only if you allow them. The strategy: customized, value-added support.
By Mark Dancer, Contributor
Distributors know the trap: Manufacturing customers demand high levels of support, but are increasingly unwilling to pay for the value-add. Products and brands are widely available, so there are plenty of competitive distributors ready to step in with equivalent products at lower prices. Also, new channels have emerged, forcing distributors to fight harder to keep customers, and redoubling their focus on matching low prices.

Distributors pursue various options to help them escape the trap: Some expand their business, hoping to become more efficient. Others walk away from demanding accounts. Some try to do both. While these plans can provide relief for the distributor, results are usually temporary. In the end, customers still get what they seek: lower prices without compromise, which squeezes the distributor even tighter. Actual change is possible, but only if customers choose to help their distributor change the way they charge for service and support. Instead of simply demanding lower prices, they need to pursue other, mutually beneficial strategies.
Get beyond price
Many customers are aggressively implementing strategic sourcing initiatives, and if they think creatively about for-fee services, this trend can bode well for new services delivered with measurable returns. But, it’s important to educate your distributors about your purchasing objectives, because most distributors view these initiatives with caution and skepticism. All too often, for example, the result for a distributor is lower prices delivered with the same level of value-added services a result that leads to reduced profits and a contentious relationship. Customers should start this process by explaining strategic sourcing initiatives using the following three-step process, then point out how distributors can help:

Spending analysis— Strategic sourcing starts with a thorough review of actual spending. Data is collected and reviewed electronically, and distributors can help this process by using their own data when the customer’s is incomplete or unusable. If distributors are sometimes hesitant to provide this information, it’s because they perceive the customers’ goal to be a simple reduction of prices. But if the customer can credibly demonstrate that they are looking for total cost reductions through improved sourcing and usage practices, the groundwork for a win-win can be laid down.

Strategic sourcing & contracting— While sourcing is often a code word for vendor reduction, contracting is a newer development, and one that’s becoming more popular. While contracting often means guaranteed prices, this aspect of strategic sourcing can also include service-level agreements. These might include guaranteed delivery times, fill rates, etc. Service-level agreements establish a floor upon which for-fee services can be offered. When value-added services go beyond the minimum, the customer should be willing to pay for real, measurable results.

Compliance management— Customers don’t achieve the often-promised gains of strategic sourcing unless there is disciplined follow-through. Throughout the customer’s organization, users and specifiers must follow new buying practices, ask for the correct brands and products, and make sure they receive proper pricing. Distributors are in a perfect position to monitor results because they take the orders. Audits and reports are standard practice for them.

But distributors can do more for their customers. They can aid the transition by training buyers on new buying methodologies, providing onsite buyers to place orders, and conducting audits to identify the next purchasing priority. Done correctly, these services essentially outsource costs from the customer’s organization, and can be structured as for-fee services built on furthering strategic buying objectives.
Communicate
The first step in making a distributor an ally in strategic sourcing is to establish an open dialogue between senior managers. When mid-level managers are the first to engage distributors, or when there is no advanced warning or explanation, distributors sometimes react defensively. Customers can avoid this by having a full and frank exchange at the start with senior managers.

In my experience, customers will consider buying for-fee services from distributors if the services reliably and measurably reduce customer costs and drive profits. Distributors are in a good position to help customers improve their operations because they are on the front lines of serving customers every day. They understand the customer’s operations, and have resources and skills that can be used to drive out costs.

Customers can kick-start this process by working with their best distributors to jointly develop and design services. Many customers already work with manufacturers to jointly identify new product opportunities, and a similar approach can be applied to working with distributors on new services. But finding opportunities for distributors to directly impact your profits is only the first step toward freeing distributors to serve you better. Customers must also demand guarantees. For-fee services remove the smoke and mirrors that can cloud distributor promises. Consider gain sharing, a simple service model. A welding distributor, for example, offers to analyze his customer’s welding operations, identify inefficiencies, and suggest training or process improvements that will lock in cost savings. An agreement is reached, and when the distributor delivers saving, they split the benefit with the customer. It’s guaranteed, and the customer does not pay a dime if the service essentially productivity consulting delivered through a welding practice audit doesn’t deliver results.
Emerging logistics models
Distributors are also learning from supply-chain services companies such as UPS, FedEx, Yellow, and other third-party logistics (3PL) carriers. These companies have found growth and profit by offering enhanced services on a for-fee service basis. In fact, among the 200 supply-chain services companies, more than 80% offer pick, pack and ship services, which looks a lot like the core competencies offered by the traditional wholesaler-distributors.

Some distributors recognize these companies as competitors and are trying to get ahead of the game by offering their traditional abilities to manufacturers under a similar arrangement. That is, they are acting as a 3PL for the manufacturer. The manufacturer gets to customize the distributors’ value-add and the distributor gets paid directly for the exact costs they incur. When successful, these leading-edge arrangements can be a win-win.

Large (end-user or retail) customers can take the lead easing the transition to these arrangements. Instead of going to leading manufacturers and demanding that the distributor/middleman be cut out of the equation, customers can ask that they be serviced through logistics-only for-fee service arrangements. The manufacturer or the customer can pay the distributor, as appropriate to each situation. And, this three-way arrangement between manufacturer, distributor and customer has the potential to be successful if all parties get to put their objectives, constraints and preferences on the table for a negotiated solution.
Set distributors free
Setting distributors free requires a shift in how distributors manage their own profitability, and how they align their resources to deliver profits to customers. It also requires guarantees that new bottom-line gains for customers will be significant, measurable, and actually delivered. Customers must start this process by doing the following:

Get the facts— – Invite your best distributors to spend time with you to explore how they might drive your costs down, marshalling their skills and resources as for-fee services. Quantify the distributor’s costs to deliver the service and measure the gains that you can reap. Create a fee structure and calculate an ROI for your business.

Question everything— – Ask your best distributors to pilot new ideas with you in order to create field-proven concepts. Tell them to find new ideas in the other markets they serve and among the manufacturer they represent. Make your distributors do the homework, and don’t allow them to fly by the seat of their pants.

Demand new competencies— – Many distributors start to develop for-fee service strategies by selling what they have always given away “for free.” You will need to help your distributors understand that you will only pay for new competencies that build on their capabilities, but are in some important way, new and different.

Begin with your best distributors— – Guarantees will be difficult to deliver right away, so start by working with your distributors that have the longest history of consistent service, close working relationships, responsiveness and innovation.

Remember the suppliers— – In many cases, it will not be possible for distributors to maximize MRO profits unless they work with their suppliers to pool their competencies and knowledge. Distributors are closer to your operations, but only their suppliers know the true capabilities of their products. Moreover, there are redundancies that can be reduced only if distributors and manufacturers agree to work together in new ways.

Many customers have whittled the fat out of their distribution supply chains by opening the door to new value-added services, paid for in a fee rather than in the margin earned by distributors on product sales. This is not charity. There is a real ROI for customers, measured in hard metrics such as lowered costs and increased productivity. By working to free your distributors you can unlock new roads to opportunity and profitability for yourself.

Mark Dancer is Vice President and Principal with Pembroke Consulting, based in Chicago. He can be reached at www.PembrokeConsulting.com. This article is adapted from Facing the Forces of Change: The Road to Opportunity, which is available online at www.nawpubs.org. 4 of 1
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