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4 mistakes that are chipping away at distributor profitability
Paul Byrnes has been in the industrial distribution industry for more than 20 years. He is the vice president of distributor development for NetPlus Alliance.
Modern Distribution Management
Paul Byrnes has been in the industrial distribution industry for more than 20 years. He is the vice president of distributor development for NetPlus Alliance.

As a distributor, even if you are satisfied with your levels of profitability, you are facing headwinds that didn’t exist until recently. Outfitting your team with tablets or investing in a new ERP system can cost a fortune. Distributors like yourself need to be as profitable as possible to stay competitive in today’s changing landscape. Here are four behaviors that are squeezing your bottom line.

1. Not Understanding The Cost to Serve

At the most basic level, a distributor needs to understand what it costs them to serve their customers. This entails knowing exactly what it costs to receive products, store products, ship orders and collect payments. How many cents on the dollar do you need to run your business? If you need 24 cents on the dollar, but your competitor needs just 15 cents, you’re at a disadvantage. By understanding how you compare to the industry, your business can make changes to operate more efficiently. I jokingly say that if I didn’t know any better, I would think that running a 20-minute mile is great. While it may be great for me, it’s nowhere near a world record. Understanding how you compare to the industry standards by checking with your association will help you make better, more profitable decisions. For example, if it costs you 17% to be in business, you should think hard before you take an order that will make just 10% margin.

Without understanding the numbers, it is like batting blind.

2. Maintaining An Unhealthy Cash Flow

Cash is king. If you don’t manage your accounts receivable and accounts payable appropriately, you may not have the money you need to pay your suppliers on time. Paying suppliers late can create supply chain interruptions resulting in lost sales, higher product cost and organizational inefficiencies from alternative sourcing, upset customers and strained supplier relationships. Profitability can fall off very quickly. This cycle may even affect your ability to add new brands, which could hurt the growth of your company and ability to meet customers’ needs in the future.

A healthy cash flow can afford distributors like yourself the opportunity to capture early-pay discounts and rebates you may be missing today based on paying outside of terms. That means more money straight to the bottom line.

3. Supporting Too Many Brands

Distributors can make the mistake of spreading inventories and cash too thin by attempting to support too many suppliers instead of focusing on the suppliers that are right for their business. Understanding the Pareto principle, commonly referred to as the 80/20 rule, for your supply chain will drive efficiencies. If a sales team lacks focus, the entire organization can suffer. Concentrating your efforts on the top brands in each category instead of everything every customer asks for will allow you to grow sales with your most profitable brands. 

Focusing on your highest-performing suppliers allows your entire team to build momentum and relationships around the brands that are good for your business. They will know your best suppliers and products inside and out. You’re selling more of these brands, which means you’re buying more frequently. This results in fewer back orders and more inventory turns. You’ll also reach freight prepaid more often, and maybe earn a deeper discount based on the increased volume. A master distributor is a wise financial option to access brands beyond your best suppliers, allowing you to right-size slower-moving inventory, increase inventory turns and create cash flow, which, again, will increase profitability.

If you buy better because of your focus and efficiencies, you don’t necessarily have to pass that cost savings to your customers. You deserve better margins. Ultimately, when your business grows, your customers benefit.

4. Not Optimizing Pricing

Many distributors determine selling price using the average margin of a product’s category rather than considering the customer’s overall volume and usage. When pricing by category, your best customer may pay the same price as a much smaller customer. That’s great for the small customer, but maybe unfair to your best customers and certainly unfair to your business, because it costs more to service smaller customers.

The alternative to category pricing is to consider the customers’ overall volume, the frequency or usage of each item, along with the product category. Thinking like this allows you to make a little more on smaller customers while still being competitive. Maybe the large customers get an item they buy all the time at 30% off list, while the smaller customer receives 25% off list. That’s $2.50 on a $50 item. So, an “A” customer would receive “A” pricing on “A” items and maybe “B” pricing on items they buy less frequently while a “D” customer might receive “B” pricing on items they buy all the time and “C” pricing on items they buy less frequently. Always be fair, but consider that it costs you more to do business with smaller customers. Delivering a $300 order costs more on a percentage-of-profit basis than delivering a $2,000 order.

You don’t have to go this alone. Pricing-optimization companies exist to help distributors develop matrixes that deliver customer-specific pricing and increased margin. Many distributors hesitate to implement a price-matrix strategy out of fear. But they shouldn’t. If done with the backing of an effective pricing strategy, it should result in fair pricing to customers and earn you the profit you deserve.   

Take the time to understand your cost to serve, increase cash flow, focus your team on the suppliers that are good for your business, and optimize your pricing. The result will be a healthier, stronger company with increased margin, so you can build for the future. Distributors are often surprised at how much extra profit there is to be gained from these four deliverables.

Paul Byrnes has been in the industrial distribution industry for more than 20 years. He is the vice president of distributor development for NetPlus Alliance, a buying group for industrial and contractor supplies distributors. Contact Paul at paul.byrnes@netplusalliance.com or visit netplusalliance.com.
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