"Unbundling"— feel like you've heard that term a thousand times in the last year? You probably have. Today, businesses focus more than ever on saving money and making more on what they sell. A big part of that process is defining the services they provide and charging for them.

Distributors today are learning to unbundle — to identify, quantify and charge for the repair, maintenance, training, delivery and other value-added services that are now included in the price of their products. In order to factor in all the variables of sales and service in a certain tool line, experts suggest breaking out those services one by one and figuring how much they cost hourly and in terms of parts and equipment. Charge fees for those services that include a workable profit.

Scott Benfield, president of Benfield Consulting Group, an industrial marketing and sales consulting company in Chicago, Ill., has tracked activity in unbundling services since 1999. He works with distributors of all sizes in nearly a dozen industrial channels on becoming service-oriented businesses.

According to Benfield, distributors can no longer grow profits on the backs of products alone. When industry was young, new products came along regularly and it was the distributor's job to take those products to customers. Today, truly new products are few, while products that match each other in price and quality are ubiquitous.

Also, there are fewer manufacturers in most markets due to consolidation, which means there are more distributors selling the same product lines.

"To deliver services, you must understand your customer's business at a very fundamental level," he says. "It's not simply being able to offer competitive products and prices, but knowing how they work and what their process hassles are. There's no better way to find out how you can help than asking customers what bothers them the most about their operations."

Benfield takes the idea of unbundling services a step further. He advocates that distributors become service-modeled businesses, changing their core competency from products to service.

"It may involve doing things like checking customers' financial records to determine where they are paying costs they don't even know about," Benfield says.

But that is also where most distributors run into the problems of time and personnel. The process of learning how to offer comprehensive services means a change in the way distributors do business. It means changing from a product/sales to a service/marketing organization.

"Value-added selling is way overdone. I appreciate the ideas behind selling products and benefits, but those are a small part of the sale and getting smaller all the time," he says. "Value, from a product sense, is not unique since a lot of distributors have the same products. Service value is unique but it must be quantified, given a price and a value proposition."

He categorizes services into three types: expected, augmented and potential. Expected services, like 24-hour delivery, are those ingrained in the distributor-customer relationship. They may be the hardest to unbundle. Augmented services are those that are consultative and specialized. Distributors must demonstrate a customer's need for them. Potential services are those that send the distributor in new directions, perhaps even into new businesses, he says.

Every distributor has experience with some type of chargeable service, says Lee Mulkey, president and CEO of Purchased Parts Group, a distributor headquartered in Memphis, Tenn. PPG is an international distributor, sub-assembly contractor and logistics/warehousing service provider.

PPG is experienced in determining the costs of services and creating an infrastructure that supports identifying, unbundling and charging for services, Mulkey says. Companies should look first at their strongest service areas, those they could most successfully transform to fee-based.

Stand-alone services have become so important for the company that PPG started a new business, Advanced Logistics Solutions, to manage them.

"I've been with companies working on the problem of unbundling and charging for services for 15 years. At Purchased Parts Group, we learned three valuable lessons: Start with a service you know very well, make sure your financial and data systems are up to the job, and begin by working with new customers or new projects," Mulkey says.

First, if you are an MRO distributor, you are intimately aware of the need for services like repair, personal delivery or overnight shipping, and training. Choose a service in which you can document savings to the customer, he says.

"When you concentrate in an area you know, you can more easily decide if you need to centralize or branch out," he says.

Distributors are more able to define the parameters of service contracts and, more importantly, include details they may have otherwise left out.

None of the details will help, however, if distributors have not pinpointed their costs. The most important aspect of the entire process is knowing all your costs before you start, Mulkey says.

"We completely rebuilt our financial systems over a period of time and, using activity-based costing, we price the various service fees. You must have good accounting systems and must calculate profitability by customer to charge correctly," he says. "Many distributors have profitability by branch, or gross margin by branch, and that just won't work. We have a plant provider program that grew in part because we had a very good idea what it was going to cost before we started," Mulkey says.

Mulkey also suggests charging new customers for services, or charging current customers only when they begin new projects with you.

"For distributors trying to get into [charging fees], it's very difficult with customers who are used to getting them as part of product costs. Try implementing a program with new customers," he says.

Another point Mulkey thinks is key to making programs work for the long term: Don't expect product salespeople to sell your services.

"You can't expect product sellers to become service sellers. Our management personnel have sold services and we have some people dedicated to selling them," he says. "We also have a start-up checklist that is very extensive — over 20 typed pages. Those details are essential when a large project is considered."

Two examples of PPG's contracts help reveal the importance of its fee-for-services model.

First, a manufacturer of faucets who purchases components directly from Asian makers approached PPG to take over all procurement activity, and stock and document fastener usage. The job includes quality assurance and delivery to production lines. Mulkey says that PPG's cumulative experience in managing small parts inventories enables them to do the job more economically than the customer could.

In another case, PPG is the stocking and shipping partner for a computer-battery backup power manufacturer. All products come from Asia into stock at the PPG distribution center in Memphis.

"We have dedicated storage, security and shipping facilities for them. Right now, we handle 1,500 shipments a week for them, all over the world. But it all came from knowing what can be accomplished in warehouse and logistics management and then proving it," Mulkey says.

Lewis-Goetz & Co., Inc., a multi-branch distributor specializing in hose and accessories for the steel and mining industries, has completed an exhaustive activity-based costing program using software from Acorn Systems of Houston, Texas.

According to vice president of operations Jim Thieman, the company began the process about five years ago. The goal is to identify the profitable services and activities provided to particular customers and to charge for them accordingly, he says.

"We use the software as a guidance system. We send our general ledger into the software, which drives the numbers to cost centers," Thieman says. "They are not always obvious. When we find an activity that is far too costly, or one that makes money, we think that, logically, we should have known that, but in reality you have to divide out activities every step of the way to see the benefits."

The process allows Lewis-Goetz personnel to figure costs through the heirarchy of the business, down to a single individual or product. The highest level costs — corporate costs — are reduced to warehouse or branch cost, then to the office costs in the branch, and so on. For example, the total corporate cost of heating and lighting is divided by the size of branches, then the size of each room or office in each building, Thieman says.

The result is a set of formulas from which Lewis-Goetz can create a report for a customer, showing exactly what their goods and services cost the distributor, and why.

The process is exacting and exhaustive, Thieman says. In old costing methods, the cost of goods was added to a theoretical labor factor that was the same no matter the customer or activity.

"But every customer and activity is different from every other," he says. "For instance, a wire-wrapped hose takes longer to cut than a plain hose. So a flag on that product tells the computation to account for more time and more expense," he says.

The system is finally bearing fruit for its intended purpose — to help Lewis-Goetz become more profitable by charging correctly for goods and services that have been historically lost in the buying-and-selling process.

"Right now, we have completed the costing factors but are using the reports sparingly. If a customer asks to have prices reduced, we can show exactly what margin we work on with them," Thieman says.

Every customer has a different set of costs because they want special delivery, stocking services, special tagging and other items. Most customers understand their situation and why Lewis-Goetz cannot reduce prices at that point, he says.

Knowing the costs of every activity means distributors will be able to set up activity-based pricing, the key to fee-for-services profitability, Thieman says.

Eventually, services will be priced based on real costs of the activity and salespeople will be paid on some basis of profitability across their customer base, he says. Sales and other personnel activities are some of the most expensive services distributors perform, he adds.

"Not many services are being charged out yet because our salespeople need to get more data about customers faster, and that is part of our next goal in working with these numbers. Fees for services will follow when the sales force can show all the facts to customers," Thieman says.

Jim Smith, owner and president of Nail Fast, Inc., a construction products distributor in Albuquerque, N.M., has spent considerable time putting the experts' suggested steps into practice. Unbundling, he says, has to begin with segmenting your customers for the best fit.

Smith was losing tool business to "big box" stores, and losing the repair business those tools would eventually require.

"We've been working on this for three to four years now. A lot of our business is with residential contractors, like roofers, lathers and framers," he says. "They would compare us on price strictly from the 'big box' standpoint. My response was traditionally, 'But our overhead is higher.' Obviously, they didn't care much about my overhead."

Many of his prospective smaller customers compared his products on a price-only basis to superstores. Not sure what to do about the problem, he calculated what he paid for tools and began to note the type and size of customer that had complained about prices.

That procedure helped Smith initiate a plan to provide better pricing to the cash-and-carry trade, represented by most of these customers. At first, they didn't want repairs and deliveries, so Smith was able to create a "pick-up price sheet," offering no service beyond factory warranty.

"When we separated out price by the 'big box model,' we automatically [segmented] our customer base into those who need to pay for service and those who don't," Smith says. "And we also reminded every customer of the value of our services if they do need it at some time. It really comes down to selling what we do, not what we have."

Smith says refining the process helped him create a "preferred cash customer" account system. He allows certain customers to have an open account for items they choose to buy, like tool repair and delivery, for which he charges a fee. Now, many of those customers realize the value of getting tools repaired regularly, Smith says.

"I do sympathize with distributors who need to get some activity-based cost information in order to charge for these kinds of items. It's difficult and time consuming. To be honest, we estimate as closely as we can a lot of these costs. But that enabled us to start charging, and we refine the process as we go. The biggest obstacle will be getting started," he says.

Many customers are cash-and-carry but may choose to purchase a service. Full-service accounts are continually reminded of the services available to them, Smith says.

Nail-Fast also employs a driver to travel to jobsites, filling emergency orders and picking up tools for repair. That helps Smith in two ways. First, he saves the cost of having outside salespeople running to fill emergency orders. Second, if a "preferred cash customer" wants delivery, he can charge separately for the service, he says.

The world of selling products has changed, probably forever, Smith adds.

"Believe it or not, our customers are paying less than half for our main products [nails and staples] than they were 20 years ago. You aren't going to grow by selling products at higher prices today," he says.