Newton, Mass. —Poor manufacturer-distributor relationships are hurting business for both parties — it's that simple, according to the Industrial Performance Group of Northfield, Ill. IPG released a report last year linking poor working relationships to a drop in sales and profits for distributors and manufacturers; but that's not the end of the story.

In an effort to drive home the importance of his findings, Robert Nadeau, principal of IPG, has quantified the costs associated with communication breakdowns. In a follow-up survey to the report, 277 respondents said the top four drivers of unnecessary costs in the channel are: fixing mistakes, expediting orders/fast-tracking, holding excess inventory, and waiting, in that order.

Seventy-eight percent of respondents to the follow-up survey were distributors. All respondents were spread evenly across the revenue spectrum, from less than $1 million in sales per year to over $50 million per year.

One of the telling factors in the survey, Nadeau said, is that when asked to put a dollar value on losses due to those cost drivers, 77 percent answered with a figure under $400,000, regardless of the size of their businesses. Those estimates are well under their true costs, Nadeau said.

He found that the loss of bottom-line revenue is greater than most respondents imagined. Nadeau calculated that loss to equal two percent of distributors' gross revenue.

"If, for example, a company's net margin is five percent, a two-percent unnecessary gross cost figure amounts to 40 percent of the bottom line. When net margins are 10 percent, they amount to 20 percent of the bottom line," he said.

The following chart shows the net effect that a two-percent reduction in gross revenue has on the bottom line, by percentage of net margin. (See chart p. 20)

Sixteen percent of respondents were in the electrical equipment business, 13 percent in power transmission/motion control, 10 percent in machine tools, and the rest were in various industrial categories, Nadeau said.

Although they have been addressed countless times, some problems persist, Nadeau said, such as the situation in which a distributor is having trouble selling a particular line and the manufacturer approaches other area distributors. The first distributor then looks for substitutes and drops the original line.

The survey results are not intended to show mistakes made prior to a factory's receipt of an order, or end-user errors, according to Nadeau. But, he said, distributors and suppliers are less than willing to admit problems on their ends, and find it difficult to raise the level of trust in sharing information.

"So, we have this distribution paradox: While unnecessary costs rise, communication has declined 20 percent since 1997 in the four critical areas that drive [those] costs. Suppliers and distributors know it's a problem, but to this point the status quo remains 'business as usual,'" Nadeau said.

The costs, he added, often get lumped into overhead expenses and therefore lose their actual sting.

Nadeau said he has sufficient numbers to start the process of showing the parties involved just how expensive mistrust and poor communication are. In fact, he said, "the structure and management approach utilized in many sales/distribution channels are much the same as they were 50 years ago."

More high numbers emerged as distributors voiced complaints about the flow of information. Seventy-five percent of survey respondents said they have inadequate access to high-quality product information; 64 percent cannot get reliable delivery and tracking information; and 61 percent are unhappy with information about product availability.

Part of building trust in the channel involves both sides understanding that costs flow upstream and down, said Nitin Bhatt, a practice leader of Grant Thornton LLP, a management consulting firm based in Chicago that specializes in mid-market companies.

"Today, supply chains compete with supply chains, rather than manufacturer with manufacturer, distributor with distributor. That's a fundamental shift in the way business is done due to technology and speed, among other factors," Bhatt said. "There are product flow issues and business flow issues, and the main component that bottlenecks the system is the human component."

If a worker in the system does not have enough information, or lacks trust in what he has, he will stop the process, he said.

"The costs are very significant. I would say they affect the bottom line greatly," he said.

Bhatt suggests an antidote for information problems: involve each other in major planning and business decisions to prevent miscommunication. That, in turn, creates trust because the business partners discuss issues face-to-face.

"One distributor had its main [suppliers] involved in choosing new computer systems because the two-way flow of information is so essential. The supplier came to the building and talked with management about what would save money and at the same time create nearly seamless communication to the supplier," he said.

Also, Bhatt said, distributors and suppliers must engage in joint strategic planning.

"Some will see this as giving out secret information, but it is just the opposite. Having the ability to plan together creates as much strength in the process as anything else," he said.

Bhatt recommends detailed analyses of business systems to find the points at which communication slows or stops, then specifically changing those bottlenecks.

"When bottlenecks are reduced, costs that go up and downstream are lowered. Policies, systems and products are the three areas that can cause problems. Each is made better when strategic planning sessions get moving," Bhatt said.

Lee Schwartz, of Lee Schwartz Profitability Group in Los Angeles, said there are tangible costs and soft costs related to mistrust in the supply chain. "Tangible costs for distributors include tracking additional supply sources when they believe suppliers are bypassing them, lost opportunities to buy cooperatively ... and loss of business opportunities because they are fighting ... instead of working to secure business," Schwartz said.

Honesty is the policy that reaps rewards in relationships, Schwartz said.

"I was president of a regional industrial wholesale company. One of our largest suppliers shipped us an order that contained $12,000 in non-invoiced product. I could have easily received them and hoped we didn't get caught," he said.

Of course, he called the supplier and, over time, got discounts and extended terms that far outweighed the original amount he might have illegally realized. The point, Schwartz said, was not the money but the relationship that was cemented between him and the supplier.

Dealing with complaints from one's own people and those of the other side sap strength.

"Soft costs are not as readily detectable but may carry a greater burden," he said. "Aggravation caused by dissension is distracting. Motivation to sell particular lines is diminished," he said.